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The company set off a frenzy when it filed to raise as much as $10 billion in cash through the IPO,
which would give it a market capitalization of around $100 billion. This could place Facebook as the fourth largest IPO ever in the U.S., behind companies like Visa, General Motors and AT&T Wireless.What do the numbers mean? Well, since the company is selling only a small percentage of its shares, its current management team, led by co-founder and CEO Mark Zuckerberg, will retain almost complete control over the company. This means new investors will have virtually no say over how the company is managed.
In addition, Facebook’s valuation is based on rapid growth. In 2010, the company had profits of $668 million on revenue of about $3.7 billion. With a valuation of $100 billion, Facebook would have a trailing price-to-earnings ratio of around 149.70. To put that in perspective, in July 2011, Microsoft(MSFT) reported 2011 net income of $23.15 billion. With an equivalent multiple, Microsoft would be worth nearly $3.5 trillion.
Analyzing Other IPOsCan it pan out? Well, in some instances, it has. Those fortunate enough to invest in the Microsoft IPO ($21 per share in March 1986) and held onto their shares through Feb. 23, 2012, would have enjoyed a 43,000% return. That means every 100 shares bought then for a total of $2,100 plus trading fees, would have grown to 28,800 shares worth more than $900,000 (Based on a closing price of $31.48; Microsoft’s stock has split nine stock times since its IPO).
On the other hand, investors in AT&T Wireless were not so fortunate. The company priced its stock at $29.50 a share in April 2000, and by October 2002, its price had drifted all the way down to $4.19. Two years later, after a series of missteps, the company was acquired by Cingular Wireless for about $15 per share.
So why the frenzy when it comes to IPOs? Those in academia, who have studied investor behavior, say that, while on average, IPOs have actually been underpriced, the median IPO based on comparative peer evaluations has been overpriced and that “results suggest IPO investors are deceived by optimistic growth forecasts and pay insufficient attention to profitability in valuing IPOs.”
In layman’s terms, this means that investors’ judgment can get clouded when analyzing a potential IPO investment. Fear and greed, which originate from two of our most primal instincts, fight or flight, are the culprits.
When we’re in “fight” mode, we tend to concentrate on the glory and spoils of victory, such as nice homes or nicer cars. Conversely, when we’re in “flight” mode, our focus turns to avoiding the dire consequences of loss and defeat, as we aim for survival and self-preservation. It’s that desire for wealth and recognition or the fear of being poor and excluded, that often drives investors to chase after IPOs without doing their research.
Usually, neither extreme comes to pass. When a company goes public, much of the profit already has been made because the owners/original investors are harvesting their gains. Long-term IPO investors can still make money by investing in profitable companies at the right price.
However, for most investors, getting in on an IPO is not likely. Brokers are allotted a certain number of shares, and they typically reserve those shares for investors who meet certain criteria (usually relating to the size of their investment account) so most will have to invest in Facebook “post IPO.”
So, the “skinny” on the Facebook IPO frenzy: The typical investor probably will not get in on it. After the IPO, those with investable dollars can buy the company’s shares, which may be a good bet for those in it for the long haul.
When it comes to IPOs in general, look for viable, long-term business models and profitability. Do not let emotions take over. Instead, make a rational investment decision and invest for the long haul. That kind of strategy builds wealth over time and allows you to sleep well at night.
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source: forbes.com
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