Facebook Made Headlines with its Announced IPO but so did Doubt on its Aggressive Valuation

On Wednesday Facebook Inc. filed papers for an initial public offering that could potentially raise $5 to $10 billion, making it the largest Internet-stock debut in history.

Although the Menlo Park, California-based company did not release any specifics as to the number of shares or a projected price range for its IPO, it did announce that it plans on debuting sometime in late April or May under the ticker symbol, "FB."

The only runner-up that comes remotely close to the $5-$10 billion proposal would be Google's $1.67 billion opener back in August 2004. But to keep things in perspective, the largest IPO in U.S. history still goes to Visa, Inc. with $17.8 billion in March of 2008.

CEO Mark Zuckerberg will exercise almost complete control over the company, reigning in 56.9% of the voting shares, but his economic control of approximately 28% of the shares could be worth as much as $28 billion (assuming a $100 billion valuation) ranking him as the 4th-richest American.

Now one of the wonderful beauties of this kind of filing is that it brings with it the release of a slew of financial performance data to the public. From there, analysts can make opinions that more often than not, in my opinion, should be heeded. Investing in IPO's can be quite a risky venture if one doesn't know the pitfalls along the way.

Facebook’s regulatory filing showed a revenue of $3.7 billion for the year ended December 31, which was an increase of 88% from the previous year. Earnings totaled $1 billion in 2011, a 65% increase when compared with $606 million in the year prior.

Not a bad performance record I must say. But the REAL question is how do those numbers relate to the ACTUAL valuation of the company? Of course learning stock valuation techniques can pretty much fulfill part of a postgraduate degree - heck, they actually do for MBA's and CFA's - and many of these techniques look at the ratio between pertinent numbers like earnings, number of shares, price, revenue, other cash flows, etc. etc. etc. We'll just take a quick and simple look at one of them to get you an idea: Price -to- revenue. Estimates peg the company's post-IPO value at $75 to $100 billion. Even on a conservative day then, a $75 billion value to a $3.7 billion revenue means that FB could trade at 20 times revenues. This could in effect make it the most expensive stock in America. The median price-to-revenue ratio for U.S. companies is about 1.4 with the more popular growth stocks like Red Hat and Intuitive Surgical trading exhibiting ratios of 8 to 10.

So could you be paying too much if you decide to buy FB during the IPO? Maybe. Even more specifically, should you even purchase this kind stock right at the open? Maybe we should take a look at other similar companies' price action histories. Did you know that studies show most IPOs actually lose money? Most of last year’s dotcom IPOs, which include LinkedIn, Groupon and Zynga, currently remain below their first-day opening prices! Google made the exception by multiplying 5 times in value, BUT it still closed higher only ever so slightly at the close of its IPO day.

Zuckerberg has also mentioned in a letter that the company will continue to prioritize building services as opposed to making profits. As opposed to making profits! I think this is very admirable and quite in line with the adage that the customer is always right, but I'm not looking at Facebook as a customer right now. I'm looking at it as an investor and focusing on services in 'opposition' to making profits makes me worry a little about the actual stock performance of the company.

So I say again, to be careful when venturing forth into the game of "Strike it Rich with IPOs" - you'd be amazed at the degree to which fluff and rumors can inflate a company's true underlying value.

Over and Out,

- Peter

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