Here we go again.
We are "back to the future" with Facebook, our most anticipated technology initial public offering (IPO) in well over one decade. As survivors of the dot-com boom and bust, we already know the drill, but this time around we should refuse to accept our marching orders. I must speculate that this pending May 2012 Facebook IPO will promptly degenerate into your typical Wall Street feeding frenzy of outrageous pomp, slaphappy backroom deals, and crony capitalism. Certainly, this Facebook IPO will expose all that is wrong with high finance and its irrational market mechanism. As usual, the bigwigs will cash out and get paid, while mom and pop retail investors will be left holding the bag of toxic assets.
Thanks, but no thanks.
The Initial Public Offering
When a private company "goes public," it sells shares within its business to outside investors through equity financing. In exchange for fronting the cash, investors are now owners of the corporation and are granted voting rights. After the initial public offering, investors can trade shares of the corporation between themselves within what is referred to as the secondary market. The value of these shares will fluctuate, according to the future profit expectations of the underlying business. The corporation hires investment banks to facilitate these series of transactions and help market its new securities to the public.
The IPO, as a necessary evil, is fundamentally flawed. In one corner, Facebook management and insiders will want to secure the highest price possible for their stock at its opening. In the other corner, outside investors will want to buy in at a low price - to improve their chances for a solid return over the long-term. Meanwhile, multi-billion dollar banking conglomerates J.P. Morgan (JPM), Morgan Stanley (MS), and Goldman Sachs (GS) will referee the deal, and demand steep fees for their services.
This thing is going to be a train wreck - before we even leave the depot.
In a "successful" IPO, shares may double in price within hours of the opening sale. The hot action, of course, is of little consequence for the rank and file. You see, the IPO will be a "success" only for Facebook insiders alongside the banks and their preferred fat cat clients, who can now dump their privately held shares onto the open market and get even more rich. Live at the circus, our investment bank ringleaders will work their magic to gerrymander an opening market that is underpriced and oversubscribed. When the smoke clears, Facebook Corporation will have left money on the table to finance its ongoing business operations, working-class stiff investors will fall all over themselves to buy into overvalued shares, and slick talking suits will declare victory on CNBC while puffing cigars and grinning like Cheshire cats.
The Web 2.0 Bubble
Facebook could not have picked a better time to go public (for itself, not for outside investors).
Investors today who scoffed at Google (GOOG) in 2004 have been forced to swallow their pride and eat dirt, as shares of that company levitated from $95 to $630. Meanwhile, the Federal Reserve Board continues to airlift cash into financial markets, which effectively forces investors to dial up risk premiums simply to beat inflation and generate real returns. At Dow 13000, several Web 2.0 outfits, such as Millennial Media (NYSE: MM), LinkedIn (NYSE: LNKD), and Groupon (NASDAQ: GRPN) have paraded themselves out of some tech geek's garage and into our cynical hearts of publicly traded relevance. All is right with the technology world, as these "can't miss" prospects surged on their first day of trading to all-time highs, only to get shellacked over the following months on the road to bankruptcy.
The stage is set.
The Facebook Business Model
As of March 30, 2012, Facebook completed its last round of private stock transactions at $44.10 per share. Financial data firm PrivCo calculates a total of 2.358 billion Facebook shares outstanding, which would therefore set the firm's pre IPO valuation at $104 billion. Be advised that through our rear view mirror, Millenial Media and LinkedIn appreciated by 92 and 109 percent, respectively, on their first days of trading. Given the hype surrounding Facebook, it would not be out of the question for the masses of sheep and amateur speculators to take a hold of this stock and drive it up by 150 percent on opening day. We would then be looking at a $250 billion corporation - that is showing a measly $1 billion earnings on its Form S-1. Facebook could therefore open up shop at anywhere between 100 and 250 times earnings.
Haven't we seen this movie before?
Although we are working with limited data, Facebook earnings growth has decelerated rapidly between 2009 and 2011. Net income nearly tripled from 2009 to 2010, before advancing from $606 million to $1 billion by year-end 2011. Although 65 percent growth remains spectacular, I am not willing to pay 100-250 times earnings for said profits, when Apple (NASDAQ: AAPL) has averaged roughly 65 percent annual net income growth over the past five years and trades at 18 times earnings (Google also trades at 18 times earnings). Of course, any earnings "miss" by Facebook would result in catastrophe for wide-eyed investors who will certainly buy this thing at the top.
Right now, Facebook is a $20 billion corporation, at best.
Mark Zuckerburg is stomping with the Big Dogs now, but he refuses to embrace raw capitalism, as evidenced by the dual structure of his baby's stock. Zuckerburg, of course, has reserved most of Facebook Class B shares for himself through outright grants and stock options. These Class B shares will not be traded publicly and carry ten times the voting power of the rank and file Class A shares. Zuckerburg, in scorned Nice Guy fashion, has overcompensated for his past failures in a power move to secure his own totalitarian regime for life. The Facebook Movement could degenerate into a complete fiasco, if this kid is unable to convert his army of 845 million users into serious cash and turns petulant.
As a Facebook user myself, I am doubtful that this "information" monster will ever mint cash at Google/Apple Web 2.0 levels. Google is more of a niche site, where the anonymous search bar allows advertisers to capitalize upon the human id, while Apple actually produces a closed circuit of products that cool people happily consume. Facebook, however, is one-part online gaming, four parts e-Harmony, and five parts public-relations campaign for common folk.
Facebook is a victim of its own success. The site is now a hodgepodge of cubicle professionals, hipsters, private corporations, husbands, ex-girlfriends, minors, law enforcement officials, and grandpa. And these are the sane users, who do not include a seedy misfit underworld of prostitutes, aspiring rappers, deranged stalkers, and Trenchcoat Mafia types. Going forward, the user experience will only deteriorate, as outcasts spend more of their time on Facebook to wreak havoc, while the elite abandon the site to avoid exposure to non-stop drivel, criminal activity, and softcore pornography.
Advertisers and investors take heed: Facebook is the New MySpace.
Thanks, but no thanks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.