For Investors Who 'Like' Facebook: 3 Buys And 2 Sells

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 |  Includes: AOL, FB, GOOG, LNKD, YHOO, ZNGA
by: Chris Lau

Using recent private trading prices, Facebook (NASDAQ:FB) would be worth close to $100 billion if it were to trade on the open market. Facebook shares rose to $40, up from $34 before the S-1 was filed, according to Sharespost trading data. Strong interest in social media stocks was nothing new in 2011. LinkedIn (NYSE:LNKD) rose 109% when it closed at $94.25 on its first day of trading. Conversely in December, when an appetite for risk declined, Zynga (NASDAQ:ZNGA) saw its shares drop 5% below its IPO price to $9.50 on its first day of trade. Last week, Facebook's IPO renewed interest in Zynga and LinkedIn when Facebook's S-1 was filed. Zynga is now $13.39, while LinkedIn closed at $79.88 on February 3.

With Facebook's $100B implying that things are different this time, there are still a number of reasons to avoid investing in Facebook. Mark Twain said it best when he said that "history doesn't repeat itself, but it does rhyme." Facebook sounds a lot like a new story. It sounds like an investment that is more innovative than the railway transport technology of the 1930's.

Here are some of the concerns about investing in Facebook:

  1. The CEO will hold Class B shares, with each share of Class B common stock entitled to ten votes per share and is convertible at any time into one share of Class A common stock. This means that Zuckerberg will own 28.4% of the shares, but will have 57% voting rights.

  2. Facebook reported 483M daily active users (DAU), but DAU connections via a third-party website that is integrated with Facebook, on a given day. Mobile users who click "like" but are not exposed to advertising count as a daily active user.

  3. Valuation is excessive. Diluted earnings per share was $0.43 in 2011 implying a P/E of 93.

  4. Maintaining growth through the ad click-through model is still questionable, even in a social media environment.

  5. How long can Facebook sustain its social novelty that resonates with pop culture?

  6. 12% of Facebook's revenue came from Zynga.

Expanding on point #4, Bloomberg reported an experimental ad campaign, where the CTR, or click-through-ratio, was 0.014%. Out of the 182,901 ad views, only 26 clicks registered.

Competitors such as Yahoo (NASDAQ:YHOO) and AOL (NYSE:AOL) are experiencing a decline in traffic and ad revenue, yet the companies generate a higher click-through ratio. In recent trading, Yahoo shares failed to break $16 and trade at a P/E of 19.41. Conversely, AOL is a buy for investors. In its 4th quarter, AOL reported that revenue grew 50% both quarter over quarter and year over year. Both cost-cutting and the acquisition of Huffington Post is helping AOL's bottom line.

Investors should take another look at Google (NASDAQ:GOOG). The company's business model includes advertising in mobile search. The company reported view rates of between 15% and 45% for display ads (at an annualized $5B run-rate). Google increased the view rate by allowing users to skip ads.

Summary:

Zynga, LinkedIn, and Facebook are speculative plays that may keep moving up on speculation. Investors should use this opportunity instead to re-evaluate Yahoo, Google, and AOL. These companies in an "old business" might find themselves in vogue with investors once again when the novelty for social media ends.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.