With so much interest in Facebook's (FB) forthcoming IPO, I feel it's time to pour a little rain on that parade -- especially in light of recent comments that institutional investors are showing a lack of interest. That will, therefore, shift the pressure toward making retail investors become the buyers.
I think many retail investors will ultimately be buyers simply because they're enamored with the company, not because they're confident in its future growth prospects. So it bears saying that just because a company's product is popular, that ultimately has little bearing on the success of an investment in that company -- especially one that's expected to have a stratospheric valuation.
I subscribe to Netflix (NFLX), but that does not mean I would be willing to own its shares. I have a Keurig at home and at the office, but thankfully have not considered Green Mountain Coffee Roasters (GMCR) until just recently. And I bank at Citibank (C), though I have so far resisted the "allure" of owning its shares. Even though I order from Amazon (AMZN) regularly, I can't wrap my head around it's valuation and therefore can't be convinced to be an owner of its shares. Of course, to date, I have been wrong on my gut feeling to avoid Amazon.
But let's get back to Facebook. My opinion is that the IPO is taking place too late for future investors to see any benefit, so I'm basically watching it as if it's a cash-out event for early-round investors. The company's SEC registration statement makes big ado about the site's 845 million active users, 2.7 billion daily likes and comments, and 100 billion friendships. But at the end of the day, how much is my "friendship" with my mother on Facebook really worth to advertisers? Or when my friend puts a picture of her puppy up, how valuable is my "liking" of that picture?
So with Facebook friendships, comments and likes generating no value to investors, Facebook's only road to increased profits lies in advertising growth -- something that so far it has not been very good at doing. In the company's most recent SEC filing, it reported 901 million users and quarterly income of $205 million, meaning each user generated about 23 cents of each (or less than a dollar per year). It's incredibly difficult to see where the earnings growth is going to come from to justify Facebook's projected valuation.
For instance, if it doubles the number of users and doubles the net income per user, the company would have quarterly income of around $820 million, or $3.2 billion per year. At a $100 billion valuation (assuming no growth in the stock price based on that fantastic move), Facebook would trade at a P/E ratio of 31, with zero legitimate chance sustaining that growth (unless the Third World suddenly becomes preoccupied with rehashing old friendships, looking at pictures of kittens, etc.).
Anecdotally, I see more and more of my friends posting to the site from mobile devices, something which Facebook has been unable to monetize so far. From a usage perspective, it's difficult to see how it could monetize those users, simply because the screen on most smartphones isn't big enough to display ads in the non-intrusive fashion Facebook uses on the desktop/laptop version of its site.
Those of us who were conscious in the 1990s will remember that the Internet is a literal graveyard of companies that thought they could turn eyeballs into unending profits. As evidenced by Friendster, LiveJournal and Myspace, users don't stick around a platform because that's where their friends are -- they find the most desirable platform and bring their friends with them. Most recently, Facebook's (i.e., Mark Zuckerberg's) recent $1 billion purchase of Instagram should give all future investors pause as they wonder how responsible the CEO-for-life will be with their earnings.
I wish any buyers of Facebook on the day of its IPO the best of luck. I think you'll need it.