Evaluating The Facebook IPO
Facebook fueled massive speculation and interest in their purported initial public offering (IPO) filing that may be due for release as early as the first week of February. The rumor grew momentum when the social media giant froze trading of its stock last week in secondary markets, hinting at a potential public offering being put on the table. Facebook is a behemoth of the internet, with one in nearly 13 people on the planet actively using it and the adoption of facebook-centric words like "friending" into the modern lexicon. It also has a reported valuation somewhere between $80 to $100 billion dollars.
Facebook has been the target of IPO rumors for a long period of time. Now that conjecture has become a reality, what should we expect to see?
SEE: How An IPO Is Valued
Why Go IPO in the First Place?
The primary reason that companies go public is to raise cash. Although Facebook has enjoyed access to an almost endless supply of private money, the Securities and Exchange Commission (SEC) doesn't allow a private company to have more than 500 investors without filing public financial statements. If Facebook is forced to act like a public company, they might as well go public to get their hands on even more money, and Facebook may raise more cash than many of the other social media IPOs combined. Why is Facebook so attractive to investors?
With more than 800 million active users, advertisers are willing to pay up to put their messages in front of the eyes of those users. Facebook technology also allows for those ads to be specifically targeted to the individual user, even more than Google. As investors know, when you can attract 800 million people to your website, you have extraordinary revenue generating power.
The Risks Involved
The recent past is full of technology IPOs that haven't lived up to the big hype surrounding their issue, and some investors believe that Facebook could be a lot of hype with little substance. Groupon is down more than 25% since its IPO, and Zynga is up only 4%.
LinkedIn, another social networking IPO has proven that there is a market for social networking stocks with a rise of 66% since their IPO, but many more have failed to impress since going public. One study found that of the 19 social media IPOs of 2011, 82% were trading below their IPO price.
If the past couple of years have taught investors anything about IPOs, it may be that it's difficult to predict how well these new companies will fare on the open market once the IPO hype fades away and that may keep many investors on the sideline until the IPO dust settles.
Should You Buy?
There's little doubt that even investors who don't normally participate in IPOs will try to get in on the offering, but should you? With the amount of investors that are trying to get their hands on shares before they hit trade publicly, it will be difficult for you to get the shares. Unless you're a sophisticated investor with a high risk tolerance, IPOs are best avoided. There will be better opportunities to purchase Facebook in the future and although it's possible that you may lose out on some profits by waiting, investing is about managing risk; in this case, the risk may be too great for individual investors.
The Bottom Line
The Facebook IPO is sure to be the biggest IPO of the year, but with that comes the potential for a lot of volatility in the stock price. Unless you're an investor with a high risk tolerance, IPOs may not be right for you.