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Facebook IPO: Buy or Beware?

Jeff Macke

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Now that everyone on earth has offered their 2-cents on the upcoming Facebook IPO, one question remains: Should you buy shares when the social networking king becomes a publicly traded company sometime in April or May?

Since we still don't know the official share price, what the total company will be valued at, or even an estimate for what the company will be earning this year, some assumptions must be made. Running through the documents released this week and what we know so far, I'm going to use the following key metrics based on what we do know about Facebook:

* The total company will be valued at $100 billion. (That's worth almost twice as much Boeing and about three times the value of Starbucks.)

* Facebook will have 1-billion Monthly Average Users at the time of the IPO or shortly thereafter.

* Each of those billion users will generate about $4.25 per year for Facebook (roughly the same as what they were worth in revenues to Facebook during 2011, according to Facebook's S1).

* Facebook's margin will remain about 30%.

That works out to a company that earns nearly $1.3 billion on $4.25 billion in revenues. At $100 billion total value Facebook will be trading at a Price to Earnings multiple, or P/E, of 77 and Price to Sales multiple of around 25.

None of which means anything in the abstract. For perspective I'll compare Facebook to Google (GOOG), the company whose IPO hype and business model that Facebook most closely resembles. Also FB is set to dethrone Google as the largest Internet IPO ever.

When Google went public in 2004 the company was valued at a similar P/E but at a mere 5x sales. The fact that Google is trading nearly $600 per share compared to its IPO price of $85, the Facebook pricing looks compelling, but only because we're applying the success Google's had over the last 8 years to what's going to happen at Facebook after it goes public. Doing so overlooks just how incredible, and hard to replicate, Google's run has been.

Google's IPO worked for long-term investors because the search engine literally became one of the best companies on earth. Google's price has gone up 7-fold since the IPO but the company has grown into it's expensive initial price.

The year of its IPO Google earned roughly $400 million on $3.2 billion in revenues. In 2011 the company reported $38 billion in revenues and earned nearly $10 billion. That works out to growth rates of over 36% per year on revenues and 39.7% on earnings.

Google's stock now trades at a P/E of 20 and P/S of 5. In other words, despite the eye-popping returns on Google's stock the company has actually gotten less expensive by the calculations of Wall Street.

Making the idea of buying the Facebook stock on the day of the IPO look even worse, Google's offering was rather famously bungled in terms of getting the maximum value for company insiders.

There are no signs of that being the case with Facebook, suggesting the measures used above will only apply to folks well-connected enough to pay the listed price for FB shares. Retail buyers (read: anyone who calls a broker or buys shares online) will have to pay-up anywhere from 20 - 40%.

Other differences are that the Google business model doesn't go out of fashion and doesn't require individual user input to make it a compelling offering for advertisers. Google looks at what people search for and sells ad space accordingly.

Facebook lures users into joining a club, determines what products customers may be interested based on what customers say, and then sells ads.

Facebook knows the kind of person you'd pretend to be at you high school reunion. Google knows the real you. The latter is far more valuable.

Facebook is also a far more mature company than Google was when it came public. With our assumption of 1 billion users Facebook will have captured 14% of the entire planet. Men, women, children living in the industrialized world or places where the Internet isn't even a dream. 14%. That doesn't leave a ton of growth for new shareholders.

Bottom Line: Facebook isn't Google, despite the surface resemblance. New shareholders could clearly see where Google could go with their business model (more searches means more ad dollars). For Facebook to replicate the growth of Google's stock will require an ongoing reinvention of the Facebook model as growth in the number of users caps out.

Sometimes it's better to watch a story play out than it is to put your money on the line based on hope and a love of the product. Take a pass on Facebook shares until the IPO dust has settled. If the company is going to be the next Google there will be plenty of time to buy shares.

Please answer our poll question below: Will you buy shares of Facebook (FB) within the first 6 months after it goes public?