Don't Be Afraid to Sit Out Facebook's IPO
I have been fortunate in my career to be intimately involved with bringing many companies to and through the IPO process while working at Morgan Stanley (NYSE:MS). Basically, I have had a front row seat. I know the team leading this effort and they are as good a team that exists in the investment banking industry.
Since the filing, I have watched many write and report on the upcoming launch and I wanted to add my two cents. Here are a few thoughts and concerns investors should have as they either participate or observe the Facebook IPO:
• If the Morgan Stanley team does its job perfectly , the share price should close precisely where it is priced. Remember , the investment bankers’ job is to get the most money for the company. If the price jumps up substantially from where it is priced, then the Morgan Stanley team didn't do a great job for Facebook. Most individual investors don't realize that the pricing determination process is very sophisticated and also very difficult. It truly is a classic Dutch auction that has many variables to consider.
• Institutional investors will, as they always do, get the lion’s share of the deal, probably 75%. Most institutional investors are not excited about the name of any IPO, they are interested in the valuation of the company coming public and its potential growth rate going forward. Individual investors, on the other hand, are the polar opposite. They like to be involved with names they are familiar with. Based on recent pricing levels and valuations, I have heard from many very large institutional investors that they are backing away from this deal.
• As a general rule, the price-to-earnings ratio on a stock should be equal to or close to the growth rate of your business. Current estimates are that the company is trying to be priced at a P/E of 100, which is very rich. To put it in simple terms, to justify a P/E of 100 you would need to be growing at about 100%. Based on the filing, Facebook's forecasted earnings growth is about 60-70% for next year. This simple formula says that the shares are coming to market, if priced at $ 30, about 40% over what is traditionally acceptable. However, if they start to charge a user fee soon after they go public, their valuation model is easily justified. Let’s do the math: a $5 charge per month will bring in $60 a year from 900 million users. That is $ 5.4 billion directly to the bottom line. I think this will happen before year end.
• Generally, individuals can get shares pre-IPO only if a number of criteria are met. They need to be accredited, meaning that they must have a personal net worth of over $1 million. They also need to have a pre-existing relationship with an advisor whose firm is part of the IPO syndication. Many brokers will try to lure you away from your current firm with a promise to give you shares. Never do this -- investing in IPOs is far from a sure thing and many go down from day one in value. If you do get shares, you will not get many, probably 200 to 500 shares. If the stock goes higher I don't expect more than 3 points on day one. I believe many institutions that do participate will be selling early on. Expect a lot of selling pressure.
• The Kardashians are very popular -- but I don't believe there is a lot of substance to them. I think the same will be the case early on for Facebook. It is very, very popular, but that isn't what makes an offering attractive. With slowing growth rates and a very high initial valuation, this is an offering that you shouldn't be upset about sitting out.
If you want to own Facebook shares, wait for 15 to 20 days and I think you will be able to buy them at a price cheaper than where they will be priced.
Ed Butowsky is an internationally recognized wealth manager. His upcoming book titled "Are You Committing Financial Suicide?" is expected to be released this spring.