5 Numbers That Should Scare Facebook Investors


If you don't want to hear anything that could spoil your Facebook (NAS: FB) coming-out party, you're better off clicking on to the next article.

There are certainly things to like about Facebook as a business, but I don't think I need to tell you about them -- they're being well publicized right now. The fact of the matter of the matter is that Facebook shares will almost certainly disappoint investors who participate in the IPO, because the prices being bandied about simply don't reflect the numerous risks that are also part and parcel of the business. Here are five numbers that highlight some of those significant risks:

23: Number of pages in the IPO prospectus describing "risks related to [Facebook's] business and industry." I recommend potential investors read every single one of them, just as they should read the "Risk Factors" section of the 10-K for every stock they own.

15%: Percentage of revenues derived attributable to Zynga (NAS: ZNGA) and third parties advertising on pages generated by Zynga apps. Everyone is familiar with Zynga's dependency on Facebook, but I've never heard anyone mention Facebook's dependency on Zynga. The social-networking game developer has to run just to stay in place, by constantly coming up with new games that will capture the attention, time, and dollars of its users, who I suspect are very fickle. Very tough business. I wouldn't classify this as a stable long-term revenue source.

57.3%: Voting power concentrated in a single person -- CEO Mark Zuckerberg -- following the IPO. Is that a risk? You don't need to take it from me, just listen to what the company has to say on the matter in the prospectus:

"As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as a result of voting agreements, in his own interests, which may not always be in the interests of our stockholders generally."

This is the very definition of a conflict of interest. If Zuckerberg finds himself in a situation where a conflict arises, whose interests do you think he's going to put first: yours or his? External shareholders will be just as well off "liking" Morton's Sea Salt Facebook page as voting their shares, for all the impact it will have.

50%: Underwriters used three methods in estimating the value of Facebook shares, one of which is simply looking at the recent prices at which the shares changed hands in private markets. Fifty percent represents the weighting the bankers assigned to this methodology.

But surely, all of the investors who bought the shares in the private markets did so based on a considered assessment of Facebook's business value. Just ask the technology fund manager who was quoted in The Wall Street Journal at the end of February -- only a few days after having bought 50,000 shares, bringing his holdings to 200,000: "Whatever you think Facebook is worth today, it's going to be worth more once it's publicly tradable." Paging Mr. Fool, Mr. Greater Fool!

71.4: Price-to-earnings ratio of Facebook shares based on a 12 months' earnings per share to March 2012 and a $35 share price -- somewhere in the middle of the most recent pricing range. Does using $35 sound like an aggressive assumption? I don't think so; indeed, according to a Reuters report from Friday, the offering is already oversubscribed, and the underwriters could well lift the pricing range.

This number is actually only marginally higher than the 67.5 P/E ratio of Google's (NAS: GOOG) shares when they were priced at $85 on their August 2004 IPO. Google's shares went on to do very well, but keep in mind that we look back at Google's share performance with hindsight. That performance happens to coincide with a period of superlative execution by the company; Google continues to dominate its market. Facebook, on the other hand, has a lower-quality business and is coming to market later in its growth trajectory. Whether it can sustain its growth and remain dominant over the next five years -- let alone the next eight -- is very much an open question.

Your best course of action: doing nothing
Facebook's IPO will almost certainly represent a poor long-term investment at or above the IPO price. If you're looking for a little excitement, why not consider the dog races? If you're looking for an informed speculation, I suggest you wait until Facebook's IPO is "busted" and the shares trade below the IPO price. Either way, you're better off sitting out this media/i-banking/technology love-fest. Alternatively, find out what our chief technology officer thinks is the best play in social media in our brand-new research report. We made it free for our readers, so grab your copy today.

At the time this article was published Fool contributorAlex Dumortierholds no position in any company mentioned. Check out hisholdings and a short bio. You can follow himon Twitter. The Motley Fool owns shares of Google.Motley Fool newsletter serviceshave recommended buying shares of Google. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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