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Facebook’s rich share price may leave little wiggle room for error

By Walter Hamilton, Los Angeles Times –

LOS ANGELES — Facebook Inc. is certain to make a dramatic entrance to the stock market Friday with its hotly awaited initial public offering.

What’s less certain is whether you should buy the stock.

Enthusiasts have salivated for months over the prospect of buying into Facebook’s surging growth rate and untapped advertising potential. They hope Facebook can mimic the stratospheric rise of Google Inc. in its early years, when its shares ballooned from $85 at its 2004 IPO to nearly $750 barely three years later.

Overflowing investor demand prompted Facebook this week to raise its expected price range to between $34 and $38, from the previous $28 to $35.

The problem for amateur investors is that only a handful of them will be lucky or well-connected enough to scoop up the stock. Most shares will go to big institutional investors or wealthy brokerage customers instead of retail investors.

As in all coveted deals, most people will have to wait until trading begins to buy. But by then, the stock is likely to be even more expensive amid the typical burst of opening-day orders.

“It’s priced to be a phenom that fires on all cylinders,” said Max Wolff, senior equity analyst at GreenCrest Capital Management in New York. “If it does that, it’ll be a great buy. If it does less than that, it’ll be a rocky experience.”

Stocks often surge on their first day as small investors rush in. Insiders and other professionals who snagged the cheaper IPO price are more than happy to “flip” their shares for a quick profit — a classic case of Wall Street “smart money” selling out to Main Street “dumb money.”

But as the buying momentum gives way within days or weeks, even prominent stocks fall back and some have trouble regaining their initial heights. That can saddle small investors with bruising losses on stocks they thought were sure things.

There were signs this week that the smart money is already heading for the exits. After the IPO price was boosted, Facebook announced that Goldman Sachs Group Inc. and other big insiders significantly raised the number of shares they’re unloading in the IPO. Their selling pushed up the size of the IPO 25 percent.

Rather than jumping in now, small investors may be better off waiting until the hype subsides, experts say.

“I’d strongly recommend against buying Facebook in the first couple of days,” said Andrew Tonner, a technology analyst at the Motley Fool. “I’m not bearish on the company in the long term … (but) the average person buying on the open market isn’t going to get a very good deal.”

Only a handful of analysts have publicly issued ratings on Facebook ahead of the public offering. They predict the stock price will reach between $44 and $49 in the next 12 months — although that might not be saying much if the stock surges on Friday.

Facebook marks the culmination of a string of social media IPOs in the last year — several of which have stumbled.

Professional networking site LinkedIn Corp. has jumped 152 percent from its debut a year ago, but daily deals site Groupon Inc. is down 35 percent from its IPO in November and 50 percent from its peak two weeks later. Zynga Inc. has slipped 18 percent from its IPO price and 44 percent from its high in early March.

To bulls, the case for investing in Facebook lies in its advertising potential, and especially the ability of Mark Zuckerberg and his team to come up with new ways to extract profits.

The 8-year-old company has fundamentally transformed the way people communicate, bulls say, and blown past all expectations by attracting more than 900 million monthly users. Zuckerberg now is turning his full attention to making money.

The company earned $1 billion last year, up 65 percent from the prior year. Revenue climbed 88 percent to $3.7 billion and is projected to rise 65 percent to $6.1 billion this year, according to research firm EMarketer Inc.

“I really believe Facebook will be a major leader and one of the premier Nasdaq stocks in the mold of an Apple or a Google,” said Scott Sweet, senior managing partner of Tampa-based IPO Boutique.

At a minimum, Facebook shares could perform well over the next few weeks, in part because index mutual funds will have to buy as the shares are added to prominent stock indexes.

Skeptics worry that Facebook faces significant obstacles and that its richly priced stock leaves no wiggle room for miscues.

After spending most of its existence focused primarily on building its platform, Facebook has made big strides luring advertising. The company got 85 percent of its revenue last year from ad spending.

But Facebook still has to prove that it can turn the rich troves of personal information that users provide about themselves into sustainable advertising growth. And it must accomplish that without sparking a backlash over privacy concerns.

The company suffered an embarrassment Tuesday when General Motors Co. said it would stop advertising on the site because it didn’t think it was getting results.

Facebook also must prove that it can master advertising on mobile devices, which more than half its users rely on to access the site. U.S. mobile advertising is expected to surge to more than $10 billion by 2016, according to EMarketer. That’s up from $1.45 billion last year.

The social media giant was late in developing mobile applications and doesn’t get any meaningful revenue from mobile products. The company warned in IPO filings that its ability to generate profits from mobile devices is “unproven.”

While all companies face challenges, investors may be less forgiving of any Facebook missteps given the stock’s rich valuation.

At $38, the shares would trade at 64 times this year’s expected earnings, according to FactSet Research Systems Inc. That compares with about 14 for Google and 11.5 for Apple.

Facebook’s valuation is based on “competing fantasies of its possible future,” Wolff said.

“Everybody wants to buy Facebook because they think they can get a lottery ticket,” said Josef Schuster, founder of IPO research firm IPOX Schuster in Chicago.

“Maybe it’s going to be as big as Apple or bigger, or maybe it will be another Krispy Kreme Doughnuts,” a once-highflying stock that later crashed, Schuster said. “For sure it’s going to be interesting.”

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