Welcome To IPO Mania and the Facebook Gamble!

By Michael Finarelli - January 31, 2012 | Tickers: GOOG | 0 Comments

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Step right up one and all. Take a spin at the IPO wheel! Try your luck at a chance for untold future riches!

As I learn more about Facebook’s upcoming initial Public Offering and the proposed valuation that it would grant the company, I can’t help but feel the sense that I’m walking through the front doors of a casino amazed at the sights and sounds before me. As I make my way out to the floor, my attention turns to the flurry of activity surrounding the game at center stage.  With a seemingly indefensible magnetic attraction, the game sucks me in.  As I take a seat alongside various brokers, traders, and let’s not forget the venture capitalists, the dealer extends his invitation: ‘Welcome to the Facebook Table.”

Before I begin to discredit the act of buying shares of Facebook upon IPO, let me first say that there is no doubt in my mind that Facebook is an extremely talented and innovative company with what will most likely turn out to be a very bright future. However, from the standpoint of successful investing there is a huge difference between a great company and a great investment!  The latter not only includes the presence of the company’s ability to increase what we refer to as intrinsic value, but it also requires paying a fair, if not discounted, price for that potential.

Having said that, is the price that Facebook will presumably be offered at upon IPO a fair price that will likely produce outsized returns for those new shareholders? Well, the most recent buzz suggests an IPO range that would translate potentially up to $100 Billion in market capitalization. Let’s put this into perspective. Below is a table of the 10 largest stocks by market capitalization (shares outstanding multiplied by stock price) as of the opening bell on the NYSE this morning.

Facebook’s prospective IPO would place the company not too far away from this top 10 list. But sheer size alone means little to us investors. Instead we need to frame our mindset in terms of future return potential. To do this let’s examine the case of Google’s (NASDAQ: GOOG) IPO back in mid August of 2004. At that time Google debuted on the NASDAQ at $85 per share which granted the company a market cap slightly in excess of $23 Billion. I personally was working in a brokerage house at the time, and I can still vividly recall the wide dissension in opinion over Google’s price. Over the last seven and a half years, Google has come to dominate the internet search era and as a result produced a benchmark smashing 32% compounded return for its shareholders by my calculations.

In similar fashion, Facebook may well continue to dominate what is termed as the social internet era, but will its stock follow in the footsteps of Google and generously reward its shareholders as well? A few key punches on my Texas Instruments calculator may suggest otherwise. Just for argument’s sake, if we simply assume that Facebook’s stock compounds at the same rate that Google’s has for the same time frame going forward, than we arrive at a market capitalization north of $800 Billion! Now, of course all of the other companies present on the list above will also continue to grow over the next seven and a half years, but with the exception of a small handful will they reach anywhere close to an $800 Billion market cap. In other words, Facebook would have to be the largest company in the world, or at least come in a strong second perhaps to Apple, in the not too distant future.  Make no mistake; this would be an achievement of truly heroic proportions.

Will Facebook ride the wave to world domination, or will its stock flounder as it’s pulled into the tide of Wall Street disappointment? I’ll let you decide for yourself. For me, there’s no way I’m even thinking about touching shares anywhere near the proposed IPO range. There are far too many other solid investment opportunities with far less uncertainty than a drastically overhyped IPO. Then again, we probably could have said the same thing about Google!

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