5 reasons to not 'like' Facebook's IPO

@lamonicabuzzMay 4, 2012: 12:57 PM ET
Facebook's profits have grown at an impressive clip over the past five years. But sales growth slowed in the first quarter of 2012 and earnings dipped. Is that a bad sign?

Facebook's profits have grown at an impressive clip over the past five years. But sales growth slowed in the first quarter of 2012 and earnings dipped. Is that a bad sign?

NEW YORK (CNNMoney) -- I sort of "like" Facebook as a company and service.

I am one of the social network's more than 900 million members worldwide. Odds are you have a Facebook account too. (Although my page is as barren as the Arctic tundra. I mainly go on just to see what my wife posts about our son.)

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However, I do not like Facebook as a stock that seems destined to go public in a few weeks with a market value of around $100 billion. I've already done an analysis of Facebook's valuation compared to rivals three months ago when Facebook first filed for its initial public offering. My colleagues at Fortune have taken another look today.

But since Facebook (FB) first filed back in February, I've noticed several additional things that give me pause. Here are five.

Slowing growth? Already? Facebook's sales surged at a phenomenal clip for the past few years. Revenue rose by more than 150% in 2010. Sales were up nearly 90% last year. But in the first quarter of 2012, revenue was up just 45% from the same period a year ago.

Don't get me wrong. This level of growth is astounding. But Apple's (AAPL, Fortune 500) top line is expected to rise 50% this year and its stock doesn't trade at 100 times trailing earnings.

What's more, Facebook's first quarter sales fell 6% from the fourth quarter of 2011. Revenue was unchanged from the fourth quarter of 2010 to the first quarter of 2011.

Isn't it a little early for a company like Facebook to be showing signs of the "seasonality" that you usually associate with more mature, cyclical businesses?

Rising expenses. Facebook says in its IPO filing that this is one of its five core principles: "Be bold. Building great things means taking risks. This can be scary and prevents most companies from doing the bold things they should. However, in a world that's changing so quickly, you're guaranteed to fail if you don't take any risks."

That's a laudable attitude to have -- but it sounds a lot like a start-up mentality.

With Facebook set to graduate from private company to one with pesky institutional shareholders, investors aren't going to be thrilled to see earnings growth declining because of rising headcounts, more capital expenditures and pricey acquisitions. Net income fell 12% in the first quarter as costs and expenses doubled from a year ago.

Sure, Facebook may be spending more for the long-term good of the company. But Wall Street is still very myopic. I applaud Facebook's management for being willing to take risks. The Fidelitys of the word may not be so forgiving if risks translate into quarterly earnings misses. Just ask Google (GOOG, Fortune 500), Apple, Netflix (NFLX) and many other momentum tech stocks on those occasions when profits didn't live up to expectations.

Zuckerberg bought what? The purchase of Instagram for more than $1 billion may turn out to be a brilliant deal. But it could also be a colossal waste of money.

Facebook investors should be prepared for the company to make more big purchases; Facebook admitted as much in its IPO filing. And because CEO Mark Zuckerberg controls a majority voting interest in the company, he may do deals that investors ... or even Facebook's board .. may not like.

While Google has done a solid job integrating multi-billion dollar deals like YouTube and DoubleClick, it remains to be seen if Facebook can also pull off a string of purchases. Yahoo (YHOO, Fortune 500) hasn't done so well with its litany of acquisitions.

Here's hoping COO Sheryl Sandberg (aka the adult supervision at Facebook) keeps Zuckerberg from overspending for something like Pinterest or whatever Silicon Valley's next social flavor of the month is.

Facebook is a media company. This fact seems to be lost on a lot of people. Like Google, Facebook generates most of its money -- 82% in the first quarter to be precise -- from advertising. That is a notoriously fickle business. Mainstream media firms like Walt Disney (DIS, Fortune 500), News Corp. (NWSA, Fortune 500) and CNNMoney parent company Time Warner (TWX, Fortune 500) don't trade at triple-digit earnings multiples. Neither does Google.

Somewhat curiously, Facebook includes a metric in its IPO filing that cable companies and wireless carriers such as Comcast (CMCSA, Fortune 500), AT&T (T, Fortune 500) and Verizon (VZ, Fortune 500) use to show how much money they generate from their customers. The number is known as average revenue per user, or ARPU.

This may be an attempt to highlight Facebook's growing revenue from non-ad sources like its payment business. Facebook gets a 30% cut of fees tied to transactions using Facebook's virtual currency.

Problem is, Facebook's ARPU is abysmally low. It was just $1.21 in the first quarter of 2012. While that's up 6% from a year ago, it pales in comparison to eBay's (EBAY, Fortune 500) PayPal unit, for example. PayPal generated $1.3 billion in revenue from 109.8 million customers in the first quarter of 2011. That works out to almost $12 per user.

Everybody is gunning for Facebook. It would be silly to suggest that any company will soon do to Facebook what Facebook did to MySpace. But it would be equally absurd to suggest that Facebook will remain the undisputed leader in social forever.

There is a lot of anecdotal evidence that more and more young Internet users are shifting to Twitter from Facebook. Google+ may still be more Diet Facebook than a true rival, but can you really count out a company that has $49.3 billion in cash? (That's almost 13 times the amount Facebook has.)

Internationally, Facebook has so far avoided China. It's not clear what the company plans for that key market. But if Facebook does decide to bulk up there, it will face intense competition from the likes of Tencent, Sina (SINA) (which owns China Twitter equivalent Weibo) and Renren (RENN).

Finally, the strong earnings of LinkedIn on Thursday -- and since it went public last year -- may be a sign that many professionals are using that site, and not Facebook, to network for career purposes.

And LinkedIn (LNKD), which Facebook interestingly mentions in its IPO as a peer for compensation purposes but not as a direct competitor, actually has a far less risky business model. Only 26% of its revenue comes from ads, a division LinkedIn calls marketing solutions. LinkedIn generates 54% from companies that pay to post job listing. The remaining 20% comes from subscription fees.

When you take all these risks into account, I really struggle to justify a $100 billion valuation. Facebook is a great company, a game changer in many respects. But it's not worth the considerable hype.

Facebook's beloved social graph could be replaced by a stock chart that points downward after the initial euphoria fades.

Best of StockTwits and reader comment of the week: Traders debate if LinkedIn is still a buy after a blow-out quarter and 10% stock spike Friday.

bradloncar: If you have over 160M users, strong revenues are going to eventually follow. Not sure why the$LNKD doubters don't see that.

True. And as I point out in today's Buzz video, I think the real beauty of LinkedIn is not just the size of the user base but the fact that they get a big chunk of it to pay them recurring fees.

jwmaden: I think $LNKD wants to become a social network not just for jobs but business content.

That probably would be a very good idea. There is clearly demand for it.

investorsmosaic:$LNKD noting weakness in Europe. Of course it's relative, but notable that they are seeing it so much to mention it.

Can't say that is a huge surprise. I've already written about how Europe will continue to be a problem for many U.S. multinationals.

dpinsen: Just checked LinkedIn and saw an acquaintance has been unemployed for 2 years. She has 500+ connections. Online Networking FTW. $LNKD

Unfortunately, I think that says more about the sad state of the labor market than the failings of social networks. But point well taken. The number of "connections" or "friends" you have won't mean much when you are trying to find a job if they are more casual than real.

Finally, I often complain about the massive amounts of e-mail I get on a daily basis. It is my white whale. Call me Ishmael. Or, I guess in this case, Ahab. But I digress.

I tweeted this morning that ignoring e-mails, like most problems, doesn't make them go away. Yaron "Ron" Reuven had a suggestion for me. And it wins him reader comment of the week.

"you should forward that quote to $GMCR mgmt," he tweeted.

Ha! Poor Green Mountain Coffee Roasters (GMCR). But something tells me that losing nearly half your market value in a day will be hard to ignore though.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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