Daily Ticker

Sponsored by

FACEBOOK IPO: Biggest Risks and Opportunities

Daily Ticker

Follow The Daily Ticker on Facebook!

Facebook's (FB) IPO should finally price this week (the target date is Friday). The offering is already more eagerly awaited than any in history, and most investors feel compelled to take a look at it.

With this in mind, here are the basic bull and bear cases.

On the bull side, Facebook's growth over the past 8 years has been nothing short of staggering. What started as a dorm-room coding project has now grown into a service used by 1/8th of the world's population. If Facebook's user growth continues, and there's no reason to think that it won't, Facebook will probably have 2-3 billion users in a few years.

The business is also off to an excellent start. Facebook only began focusing in earnest on the business side three years ago, and it has now amassed $4 billion of revenue and $1 billion of profit. The company's operating margin is extraordinary--50%--because it doesn't have any content production costs (the users do all the work). Given how central Facebook has become to many users' lives, many people think that Facebook will ultimately be bigger than Google, which currently has $40 billion of revenue.

Bullish analysts think Facebook will have $20 billion of revenue in 3-4 years and $2+ of earnings per share. If you believe that, the stock is probably a good buy at the IPO price (assuming the price is under $100 billion).

But then there are the negatives, which are also worth thinking about.

  • First, the company's valuation is already very rich. Everyone in the world knows about Facebook's huge opportunity, and if the IPO prices at $100 billion, the stock will already be trading at ~40X 2013 estimated earnings. This compares to Apple, the hottest company in the world, trading at less than 15X earnings. Apple, meanwhile, is still growing faster than Facebook.
  • Second, Facebook is classic "muppet bait." It's hard to imagine an offering that has been more widely anticipated and hyped, so the chance that you have an "edge" is tiny. (See also: Facebook Is "Muppet Bait")
  • Third, Facebook's growth is decelerating, and its profit margins have probably peaked. Until growth reaccelerates, it's hard to see how the stock will sustain a major upward move, especially at the expected trading price (over $100 billion)
  • Fourth, the rapid growth of mobile represents a major change in usage patterns and a possible threat: Facebook is unlikely to be able to generate as much revenue per user from mobile as it does from the web, and the world really is going mobile. (Facebook actually just cited this in its latest IPO filing amendment).
  • Lastly, to his credit, CEO Mark Zuckerberg has made clear that he is willing to sacrifice short-term performance to build his long-term mission. He has also said, amazingly clearly, that Facebook's social mission is more important to him than its business. That is a three-alarm klaxon warning short-term investors away from the stock. Even if Facebook is as successful at building its vison as the similarly long-term focused Amazon was, there were many, many years in which Amazon was a lousy investment.

The bottom line is that, as always, price matters. At $100 billion, Facebook will be valued at about half of Google's valuation, despite having only 1/10th the revenue. That means that Facebook's future will have to be really spectacular to give investors a great return from here.

The one the investors should not do is confuse familiarity with Facebook's service with the stock being a good buy.

Stay tuned for more Facebook coverage from The Daily Ticker and check out our previous coverage below!

Facebook IPO: Not For The Average Investor

Surprise! Turns Out Mark Zuckerberg Is A Great CEO

Facebook's "Defensive" Instagram Deal Could Spur Flurry of Tech M&A: Josh Brown

Robert Shiller Eyes Another Tech Bubble: "There's Going to Be Huge Fortunes Made"

Facebook Fights for Users' Privacy -- Against Employers Who Ask Job Applicants for Passwords

Facebook Investors Should Be Worried By Pinterest Mania: Fortune's Hempel

View Comments