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

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.


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.