Facebook Twisting Its Own Knife?

05/17/2012 3:50 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

A number of last-minute machinations before the year's big IPO should give pause to any long-term investor trying to buy in, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

What a terrible offering.

Yes, the Facebook (FB) initial public offering tomorrow, May 18, is beyond full of the normal fundamental uncertainties. That comes with the turf for hot IPOs in my opinion.

But the structure of the offering just keeps getting worse and worse for investors. If you can get shares at the IPO price, buy them and flip them, by all means. But you sure don’t want to think this is a long-term investment.

I think the fundamental problems with the Facebook offering should be known to all at this point, especially because General Motors’ (GM) decision to pull $10 million in advertising from Facebook—just days before the company’s IPO—has focused attention on all the questions about Facebook’s ability to grow its ad revenue.

Here are the important fundamental numbers. At a likely post-IPO market value of $100 billion, the market is saying that every person with a Facebook page is worth about $100.

In 2011, each Facebook user generated about $4 in sales for Facebook. That’s a lot of ad revenue to generate just to get to the post-IPO valuation. And Facebook’s ad revenue actually fell in the first quarter of 2012 from the fourth quarter of 2011.

But what really bothers me about the IPO is that the terms of the deal are still changing, and they’re changing in favor of pre-IPO investors who want to cash out, and against anyone who buys after the IPO and holds onto the stock.

Here’s the problem. Facebook updated its S-1 offering document yesterday. All the headlines have gone to the increase in the size of the offering: including the option to sell more shares granted to underwriters (what’s known as the greenshoe), the offering size went to 484 million shares, from 388 million.

But the S-1 also changed the lockup on the offering. Lockup provisions restrict how quickly pre-IPO shareholders can sell their shares after the IPO. The purpose of these restrictions is limit the pressure on the post-IPO price that would come if a lot of pre-IPO investors dumped their shares on the market all at once. The traditional lockup period is 180 days.

But after the changes to the S-1 Facebook has an unusually short lockup period of just 91 days. That would double the free float—the number of Facebook shares that trade on the market—from 484 million after tomorrow’s IPO to 1 billion after 91 days.

At the high end of the IPO range, that would amount to $10 billion in Facebook stock that the market might have to absorb.

That’s a lot of overhang. Investor beware.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of December, see the fund’s portfolio here.

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