Wow I almost got out of here without doing a post on Facebook. That company's shares, you may have heard, will start trading on Friday in the most anticipated IPO since someone first trotted out the wheel in 8,000 B.C.
There may be good reasons to buy Facebook stock besides the fact that a desperate California is counting on taxes generated from the IPO to help cobble together a budget. Facebook set the per-share range at $34 to $38, but yesterday the Legislative Analyst's Office calculated state revenue for the next year assuming a share price of $45 six months out. At least two stock analysts -- not from the government -- are already bullish on the 'Book, having weighed in with Buy ratings.
Sam Hamadeh is not one of them. He's the CEO of PrivCo, an IPO research firm based in New York. His advice: If on Friday you've got your finger on the buy button, take a cold shower or play some Words With Friends instead. His reasons why in this interview with KQED's Cy Musiker today...
CY MUSIKER: One reason you're bearish: You did an analysis based on the company's 1st quarter results. You noted Facebook is having trouble making money off of advertising on mobile devices. Why is that an issue?
Reasons to sit out the IPO
- FB doesn't have good way to monetize mobile users yet, and more than half of users access the site that way.
- FB costs are growing much faster than revenues.
- Much of FB's growth in users coming from developing nations, which advertisers don't pay to target.
- FB has been unable to show advertisers a direct translation from ads-viewed to purchases.
- Increase in insider selling may be worrisome.
- Most recent tech IPOs have tanked.
- Current FB valuation should be $25 per share.
PRIVCO'S SAM HAMADEH: It's an issue because what we saw in the 1st quarter is that Facebook had its slowest revenue growth rate in its history, and in fact it showed one of the only quarter-to-quarter revenue declines in advertising in Facebook history. Facebook's ad revenue fell from the 4th quarter of 2011 to the 1st quarter of this year.
And one of the key reasons is that more and more users are accessing Facebook on mobile devices. Just based on space limitations, mobile devices can't show those seven ads per page that Facebook has been used to. It's a real issue.
CY MUSIKER: And more than one-half of users logon via smartphones and tablets.
SAM HAMADEH: That's correct, and as Facebook said in a recent filing late last week the move to mobile is happening much more rapidly and has caught Facebook off-guard. At this time Facebook doesn't have any strong ability to monetize mobile users the same way they do on the website. And so this rapid shift has continued in the 2nd quarter and they don’t see it abating anytime soon, if ever.
CY MUSIKER: You also raised a red flag in that much of the growth in Facebook users is coming from developing nations…
SAM HAMADEH That's a two-sided coin. On the one hand it represents an opportunity, of course. They're moving into developing markets early, countries like Cambodia, Nigeria, Vietnam. The downside is that those are cost centers for Facebook. Those users still upload photos and videos costing Facebook money to host them -- in fact we saw in the first quarter that Facebook's data server and hosting costs almost doubled from the prior quarter despite revenue growing just under 50%.
So costs for Facebook are growing much faster than revenues, and one of the main reasons is that so many of the new users are coming from developing countries, and advertisers just don't pay to target those people at this point, or will any time soon really.
CY MUSIKER: A poll this week found Facebook users are reluctant to make purchases by clicking on Facebook ads, and GM announced yesterday that it plans to stop spending 10 million dollars on Facebook ads. Is that significant?
SAM HAMADEH: I can't think of a worse time for GM to make that announcement. To have right before the IPO one of the three biggest advertisers in America come out and say it's cancelling it's entire $10 million advertising spend is embarrassing to Facebook and of course it's concerning. A lot of advertisers look to those big advertisers like GM as sort of leadership to guide them where to spend their money.
CY MUSIKER: But Ford mocked GM's decision, and a lot of advertisers are entranced with the way Facebook lets them target their ads so effectively, because users voluntarily reveal so much about themselves.
SAM HAMADEH: I would say it's a mixed bag. There's no question a lot of advertisers feel like they have to be doing something on Facebook at a minimum, a little bit of spend just for learning. But the problem is that for the most part Facebook has been unable to show a direct translation from ads viewed to actual purchases. At some point they have to come up with more data and metrics the same way Google does and Nielsen does for TV advertising. They have to be able to show direct return on investment to advertisers.
CY MUSIKER: The Wall Street Journal reports a number of insiders are selling a significant share of their holdings. That includes some Facebook directors. Are they bailing on the company or just taking advantage of a chance for profits?
SAM HAMADEH: I think it's a combination of things. A good chunk of insider selling is tax-related. Zuckerberg is selling roughly $1 billion of stock into the IPO, but he's using some $900 million of it to pay taxes to California and the federal government. He is pocketing $142 million by PrivCo calculations.
But there is a lot of selling going on. It's starting to get to the point where it should be a little bit of a warning sign. At the same time, with demand being there, you can't really blame people for taking money off the table, especially at such a high valuation.
CY MUSIKER: In regard to recent tech IPOs, like Groupon, Yelp, etc., how well have investors done who have gotten in the first few days or weeks?
SAM HAMADEH: Except for LinkedIn, which has performed exceedingly well, every other company has performed quite poorly. Every investor who bought Groupon, Zynga, Pandora, etc on the first day of trading has lost money.
It's something to keep in mind: Just because a company is a good company doesn't make it a good investment. And I think people really should be cautious at such an expensive valuation for Facebook. You can still like Facebook and the trend it represents without buying it as an investment.
CY MUSIKER: What would you pay for Facebook shares?
SAM HAMADEH: PrivCo values it at $25 per share using pretty standard investment-banking-type methodologies. That's the fair value of Facebook stock today. Anything above that now would indicate overvaluation and a reason to sell not buy.
It will go to market around $38 and will probably open for trading well above that. Even if you're tempted to buy shares on the first day, use a limit order. At least set an upper limit, whether that's $45 or $50 so that you suddenly don't find yourself buying shares at $100 without realizing it.
CY MUSIKER: Are there signs of shorting yet?
SAM HAMADEH: Not a lot of signs of that. It would be a very risky short. If someone were to short, you might want to go long in what's called a pair trade. If you went short on Facebook, you'd go long on another company like a Google or a LinkedIn, without recommending a specific stock, so that if social media goes up, you have a hedge against it.