Why I won’t be buying shares in Facebook

By MoneyWeek Editor John Stepek Feb 02, 2012

John Stepek

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It’s the moment investment banks have been waiting for.

Facebook is going public. Yesterday, the social networking company announced plans to list on the stock exchange. It’s a move that could raise as much as $10bn from investors, and end up valuing the company at $100bn.

This is just the start of the process. The company won’t actually be traded until around the middle of the year. But I suspect the Facebook IPO will be a big success. There’s too much riding on it for it not to be.

But I won’t be buying in. Here’s why…

There are loads of reasons to be sceptical about Facebook

I’ll admit that when it comes to big flashy tech stocks, MoneyWeek tends to be too sceptical. We weren’t keen on buying into Google when it listed at around $85 a share, and the company’s huge success has proved us wrong since. And as my colleague Phil Oakley noted earlier this week, we’ve been too cautious on Apple as well – its recent results suggest there’s a lot more growth to come.

And my gut feeling is that the Facebook IPO will go down well. It’s a big name, there is a huge amount of excitement about it, and I would be surprised if the shares tank when it lists.

Yes, other IPOs in the sector – including LinkedIn (the business version of Facebook), Groupon (a discount voucher website), and Zynga (a social gaming company) – haven’t exactly set the world alight.

But chances are, that’s because investors have been saving their pennies to buy into Facebook. After all, the US Securities and Exchange Commission’s website almost crashed yesterday as it was overwhelmed by traffic. This listing has been a long time coming, and lots of people want to get in on it.

And sure, you can criticise the fact that Mark Zuckerberg will still be able to do what he wants with the company. The Facebook chief “and his close allies own 57% of the company”, as the FT reports. Zuckerberg himself controls 28%. That means shareholders are along for the ride, rather than exercising any influence as owners.

(By the way, if you saw the very enjoyable Facebook film, The Social Network, and went away feeling sorry for his wee pal and co-founder Eduardo Saverin – don’t worry, Ed’s going to be made a billionaire by this float too.)

But this is what you get with visionary technology companies. Google has the same sort of structure. And I’d rather buy stock in a company led by a highly committed, heavily invested founder who cares about his creation, than one that’s been hijacked by employees who only care about their next pay packet (yes, I’m talking about the banking sector).

So I think there’s every chance Facebook won’t disappoint on its IPO.

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Investing, not punting

But will I buy it? No. Because investing is not about taking monumental punts on companies which you only vaguely understand. It’s about forming a clear understanding of the risks and rewards involved in buying a company, then deciding whether there is enough potential reward to make taking the risk worthwhile.

One undeniable fact about Facebook is that it’s already looking very expensive. As Rob Cox of Reuters Breakingviews pointed out, “everyone who’s anyone” in investing or Silicon Valley has already “made a killing” off the company by taking private stakes earlier in the company’s life. “The worry is that after the investing aristocracy has feasted on Facebook, there’s little left for the hoi polloi.”

Google, says Cox, went public earlier in its existence, so it hadn’t been hawked around as much. To match Google’s performance, Facebook “would need to become the world’s first $700bn company”.

Can it do that? Facebook does make money already. But the argument – just as it did in the dotcom bubble – still very much hinges on ‘eyeballs’.

Companies' advertising money flows to where their customers are. Google makes money by being the motorway that we all use to traverse the internet. Companies pay to stick billboards on the side of that motorway. And because Google knows what we search for, it can make sure the billboards are particularly relevant to us. That’s very attractive.

As far as I can see, this is also the main selling point for Facebook. It gets lots of people using it – either to talk to their pals, or to find interesting things on the internet – and it advertises to them.

Trouble is, it’s harder to ‘monetise’ Facebook. That doesn’t mean that they won’t find a way (although WPP chief executive Sir Martin Sorrell, who should know his stuff when it comes to advertising, is sceptical).

But if you buy Facebook for the long run, you’re betting on its ability to make an awful lot more money than it already does, in order to justify its valuation. Given that there are a lot of well-established tech stocks that already make plenty of money, and sport a much lower valuation – such as Microsoft (Nasdaq: MSFT), or even Apple (Nasdaq: AAPL) – I don’t see that the risk / reward balance here is attractive.

This is the nice thing about being a private investor. Lots of index-tracking fund managers, or guys in the tech sector, will right now be suffering painful cognitive dissonance. “I’m not sure this stock is worth it, but I have to buy it, because it’s such a big name, and everyone else is going to buy it, and I’ll look stupid if it goes up and I don’t.”

You don’t have to care about that. Facebook might go up in value. So what? There are plenty of other stocks out there going up in value too. And better yet, not all of them rely on you taking a flying leap of faith that a brainy 27-year-old will manage to stay ahead of the zeitgeist for the next five years.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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Published in Share tips | More articles by John Stepek

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  • 1. Jim0707

    (02 February 2012, 11:26AM)  Complain about this comment

    I completely agree. I would add that data show that most IPO valuations are bubbly, and serve to enrich private equity firms selling out at IPO. In the case of Facebook, the valuation of up to $100bn is excessively bubbly by any yardstick (100x earnings in 2011) and can only be justified by aggressive growth assumptions. Is this likely in highly competitive cyber space?

  • 2. Jack Adams

    (02 February 2012, 11:36AM)  Complain about this comment

    This is a very pertinent article and puts an argument against "jumping on the bandwagon" in no uncertain terms. The key point for me is the issue about private investors worrying when they see a share they haven't invested in grow in value. Time and again I tell my colleagues that the key to long term success is sticking with your strategy and not worrying about what you miss but focusing on what you have.

    Facebook presents itself as an opportunity and, as the article says, some managers will be jumping on board because of profile not because of strategy. This is the worst possible decision to make. The problem for the small and middle sized private investor is that they could also be seduced by this Hollywood IPO. The caution here is that Hollywood is about myth not reality. Facebook looks to me like a high risk investment for the long term private investor. No sale here either.

  • 3. Alan Ractliffe

    (02 February 2012, 12:09PM)  Complain about this comment

    I think there are 800m facebook subscribers which means each subscriber is being valued as an asset of $100. So the company needs an average annual advertising earning of at least $10 per subscriber for viability. Is that a realistic expectation? I don't know.

  • 4. modsa

    (02 February 2012, 12:26PM)  Complain about this comment

    I'm odd: I don't like investing in a company where I can't go to the AGM, I think the company will be vulnerable to changes in fasion and technology, and there is a danger that the founder will overreach himself.

  • 5. Boris MacDonut

    (02 February 2012, 04:12PM)  Complain about this comment

    John is right to be sceptical. Much euphoria surrounds Facebook, but it has an unproven record and is likely to be no more than an over-hyped fad and a dotcom bubble. It claims 800 million users,but many accounts are dormant or duplicated.
    Fewer than half of users visit even 5 times a week, giving it much less penetration than TV or Radio. 65% of its users are aged 13 to 34 and almost 60% of them are female and 30% American. It is a limited demographic. A great place to reach young, mainly US women, but largely irrelevant to the middle aged males who actually have the money.

  • 6. Boris MacDonut

    (02 February 2012, 04:17PM)  Complain about this comment

    It goes without saying that with just 5% of the global populace regularly using Facebook a valuation of 5 times that of BP or HSBC is plain daft. Zuckerberg has elements of duplicity about him too......as they say " pop goes the weasel".

  • 7. jrj90620

    (02 February 2012, 04:19PM)  Complain about this comment

    An analyst on PBS Nightly Business Report said she has spoken to many young people and was told that they were tired of Facebook and moving on.Not good news for this company.The only time I use Facebook is when I'm forced to by some company that wants me to "like" it.Don't understand Facebook.

  • 8. Marsipan

    (03 February 2012, 06:55AM)  Complain about this comment

    Facebook is great, I'm a young 23 year old, and I use Facebook everyday to reach my friends. My generation is obsessed with ego, and we go to Facebook to get our daily dose of self gratification. It doesn't really give value, besides our false images of ourselves. I think like Myspace, once it gets publicized, people will stop wanting to use it unless if they find a way to make the user experience personal without being bombarded with ads. Currently I'm already getting annoyed with all the advertisements that are being spamed in my news update collumn.

  • 9. Anon

    (07 February 2012, 01:05PM)  Complain about this comment

    Interesting article...

  • 10. Benji

    (16 May 2012, 05:36PM)  Complain about this comment

    I agree with Marsipan, although everyone is obsessed with it, they be forced away by the necessity for aggressive advertising. This is a pure gamble, and with the likes of IG it isn't cheap either.
    Also, take the recent New Zealand service launch where people pay for priority posting. It will be interesting to see what the ramifications are from that :o

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