x Abu Dhabi, UAETuesday 23 January 2018

Facing the facts of the Facebook IPO

Facebook's upcoming initial public offering is not only not good value, buying it is tantamount to a rip-off.

"At the end of the day, if you have a small amount of money and you are in a position to lose a chunk of it, go ahead and speculate on Facebook," says Scott Schermerhorn of Granite Investment Advisors.
"At the end of the day, if you have a small amount of money and you are in a position to lose a chunk of it, go ahead and speculate on Facebook," says Scott Schermerhorn of Granite Investment Advisors.

It is rare, indeed, for the general public to get excited about new offerings on the stock market. Unless people have known the company and used its products for decades will its arrival in an investable form be of more than just passing interest.

People generally show interest in an initial public offering (IPO) when a household name such as the country's post office or telecommunications company decides to go from state ownership into private ownership and offers incentives to do so. Internet companies, even despite the technology run in the late 1990s, have never had this cache at their stock market births. Google was not a household name when it listed in 2004, nor were Apple and Microsoft when they listed in the 1980s.

Facebook, the world's biggest online social network, is an exception to this rule. Almost one seventh of the world's population uses it to some degree. It is less than a decade old, yet its brand is unchallengeable - what's more, you don't have queues (unlike the post service), it allows you to connect to anybody you know and plenty you don't for free (unlike a telephone company). It ticks all the right boxes - smart technology, entrepreneurial, carbon neutral and 100 per cent free.

At first sight, this looks like the first ever truly global float of a company, one that people of all races, creeds and religions can partake in equally. Nobody seems to be controlling it. This is the company that, while grappling with privacy issues, is still largely viewed as pristine. It has no hierarchy, no bureaucracy, few rules of engagement and offers instant benefits.

That's what Facebook looks like, but its IPO, through which it aims to raise US$10 billion (Dh36.7bn) in the spring, is going to be something very different. If you want a piece of the action and live outside the United States, do not bother. Unless you are rich or famous or have impeccable stockbroking connections within the US and wield enormous investment clout, you will have no chance of getting your hands on pre-IPO Facebook shares.

Facebook is expected to seek a $100bn valuation from its IPO, the most anticipated stock offering from Silicon Valley since Google eight years ago. But the problem is only 5 per cent of that figure will be available to "elite" investors from its IPO - the other 95 per cent has already been portioned out to early private investors, senior Facebook executives and employees, as well as big institutions and pension funds.

At a $100bn valuation, Facebook, led by the 27-year-old Mark Zuckerberg (who owns 28 per cent of the shares), is seeking a multiple of up to 27 times annual revenue, or up to 100 times earnings. This is not dissimilar to Apple, the world's most valuable technology corporation, now valued at $460bn. When Apple went public in 1980, it was valued at $1.19bn, equivalent to 25 times revenue and 102 times earnings.

Relative to most other kinds of shares, Facebook's valuation is preposterous based on its share price in relation to its expected earnings. The average valuation of a company on the US stock market is about 12 times earnings. High growth companies may trade at 20 to 25 times earnings and that is already considered expensive.

In other words, Facebook is not only not good value, buying it is tantamount to a rip-off.

Its proponents would demur. It has 865 million users. It has been profitable for the past three years. The company reported revenues of $3.7bn last year, an 88 per cent increase over the previous year, and earned a $1bn profit, more than Google's total revenue the year it debuted on public markets.

More than half of its subscribers return to the site daily. These hundreds of millions of users have shared more than 100 petabytes (100 quadrillion bytes) of photos and videos with Facebook and produced an average of 2.7 billion "likes" and comments a day in the final three months of 2011.

Let's compare it to a mature company. What about BHP Billiton, the Australian mining behemoth that has been around for more than a century? Admittedly, it's hardly a like-for-like comparison. BHP is the world's biggest miner, Facebook is the world's biggest internet social networking site. But remember, you, the investor, are free to invest in both.

BHP can be easily bought by any stockbroker around the world. Most brokers have access to an international platform on which to place orders. BHP is capitalised at $183bn. That's nearly twice the size of Facebook. BHP revenue last year was $71bn, its earnings $32bn and its 2012 profit is forecast to hit $20bn.

It is 20 times more profitable than Facebook and what does it cost to buy? Its share price is trading on about eight times earnings. So this company is 18 times more profitable than Facebook, trading at roughly one twelfth of its price.

Facebook still good value? You're the investor. "We had some clients call and once we step them through the numbers, they sober up," says Scott Schermerhorn, the chief investment officer at Granite Investment Advisors in New Hampshire in the US.

"At the end of the day, if you have a small amount of money and you are in a position to lose a chunk of it, go ahead and speculate on Facebook."

On the other side of the world, Lew Fellows, at Patersons Securities in Australia, is just as wary.

"On a fundamental basis, we would say you'd have to have a lot of faith that it would continue to grow at the rapid rate it has been. We find it a bit of a stretch."

Mr Fellows says that for such a limited supply of stock, the demand will be so great on debut that the price could move into the stratosphere within moments of listing. This is what the early investors are all hoping for. Once the stock is bid up to ridiculous levels, the founding fathers of Facebook will sell - and suddenly the general public will find shares that yesterday were as rare as hen's teeth, suddenly available at outrageous prices.

Soon after, as more stock is sold, prices will plummet, moving to a figure closer to a true valuation of the company. At this point, the investor will be left with a share shorn of its hype (and its price), which will have to sustain itself based on its own fundamentals.

Those who keep the shares have to believe that Facebook can attract more and more people at a terrifyingly fast rate and be able to turn that subscriber growth into profit.

"There will be the obvious short-term ability to make money at the IPO, but long term, who knows?" Mr Fellows says. "Any business trading at 100 times its earnings will have its work cut out. What we see at the IPO - versus the price it will get to in 12 to 18 months' time - are likely to be two very different things."

So there it is, if you can get a piece of the Facebook action before its IPO, you're likely to be a big short-term winner. Then again, you're probably the kind of person who has his dry-cleaning sent daily to Paris, gets his newspapers sent express from New York and travels to London to ensure his suits fit.

The rest of us have to believe that the prospects of this phenomenal social networking site are a good long-term bet. Then again, we can always invest in a steady old-world company ... like Apple.


The Facts

Although it is generally considered impossible to get shares in Facebook’s initial public offering (IPO), soon after it lists, investors the world over will be able to buy the company’s shares with very little difficulty. In most cases, a local stockbroker will have connections with the US domestic market, but some legal issues apply.

For regulatory approvals of foreign ownership of US domestic shares, stockbrokers tend to register the holding as a nominee company on behalf of a client. Most broking houses will have this nominee service available. “Ensuring that stock is registered to your beneficial ownership in a nominee company is the easiest way to ensure all is compliant with the US Securities and Exchange Commission,” says Lew Fellows, at Patersons Securities

in Australia.

Potential investors in Facebook should remember that an IPO is a once-off opportunity for shareholders in the former private company to make money. When you buy an IPO share, you are paying the price of that newly issued share direct to the company.

An IPO is about a company tapping the public for funds to provide for its future growth, to repay debt or amass working capital. When we trade shares after an IPO, we take a slice of the company, paying each other the going price that the stockmarket sets, hoping to make money for ourselves – not the company.

Once it is listed, the Facebook we now know will become a publicly scrutinised entity, having to disclose its business strategies and financial information quarterly.

It will be pored over by analysts and assessed constantly. It will be required to pay much higher legal, accounting and compliance costs. Facebook will almost certainly cash in on its debut, but the price of listing is eternal public scrutiny.