Aurum Wealth Management Blog

Aurum Access – Facebook IPO, It’s Zuck’s World & We’re Just Friends in It

From its humble beginnings in a Harvard University dorm just over eight years ago, Facebook changed the social interaction protocol and Internet experience. One out of every seven minutes spent online is on Facebook.[i]  Customary is it now to share photos of loved ones, rattle off personal quips, or acknowledge ‘friendship’ of fresh or old acquaintances on the site.   For some of the 900 million users, this is a new experience while for others simply a part of the daily routine.  What is new for everyone is that this social network is set to offer its fractional ownership to the public markets in the largest U.S. initial public offering ever.

Facebook will raise up to $18 billion in the public markets, allowing employees and early investors to cash out a portion of their shares and the company to fund its growth.  How does it make money?  About 85% of revenues come from advertising with the balance mostly from games.  Four million businesses setup company pages (at no charge).  This is a real business making real money.

Facebook truly changes the game with targeted advertising.  Per the IPO filing, “Advertisers can specify that we show their ads to a subset of our users based on demographic factors and specific interests they have chosen to share with us… We offer advertisers the ability to include ‘social context’ with their marketing messages.  Social context is information that highlights a friend’s connections with a particular brand or business, for example, that a friend Liked a product or checked in at a restaurant.” For example, when a woman gets engaged she updates her relationship status on Facebook on average within two hours.  This allows bridal shops to buy data from Facebook and place ads during the user’s online experience.[ii]  Essentially, this is the Holy Grail for marketers targeting a niche clientele.

The unanswered question everyone has is, does the advertising work?  According to Business Week, Facebook gets 1/5th of the clicks on banner ads compared to the web as a whole.  An anecdotal story from General Motors did not bode well for efficacy of the ads, as GM canceled its $10 million annual spending on Facebook.  The story still seems evolving on whether the ads drive sales for businesses.

In 2007, Microsoft purchased a 1.6% ownership of Facebook that valued the entire company at $15 billion.  Goldman Sachs’ investment in 2010 placed the value at $50 billion.  Earlier this month, the offering estimated value of the company was between $77 billion and $96 billion with the price range of $28 to $35 per share, according to the Wall Street Journal.  Due to investor demand, the valuation range increased to $93 billion to $104 billion and a range of $34 to $38 per share.  In addition, on Wednesday it increased the shares being offered by 25%, up to 421 million shares.  The chart below shows Facebook trading on the private stock exchange SharesPost over the past year through March.

Facebook grew revenues by 150% in 2010 followed by 88% in 2011, but growth dipped to 45% to the first quarter of 2012 compared to 2011.  This does not compare well to Google’s pre-IPO run rate, as it grew revenues 139% in 2003, 86% in 2004 (when it went public), and then accelerated slightly to 88% in 2005.

Compared to the disruptive technologies of Amazon (in retail sales) and Google (search), Facebook has an astronomical price to sales ratio and a price to EBITDA between the two.


(in $millions)




Total Market Cap (Value)




Revenue (Last 12 months)




Revenue Quarterly Growth (Year over Year)












Source: S-1 Filing and

Investors seem to be betting that growth will come, regardless of the source, especially with the lofty valuations.  It will have to continue a 30%+ growth rate for the next couple of years to justify the current price.  Facebook could spread its business into new spheres such as payments, subscriptions services, and much more, by providing the plumbing of social connections.  The global nature of the platform provides massive opportunity.  Many analysts think it could disrupt Google’s stranglehold on ‘search.’  And though it does not have a strong mobile app, more than 50% of visits to Facebook now come from mobile.  If it could harness this rapidly growing user interface, revenues will follow.

In Mark Zuckerberg’s letter to prospective shareholders in the IPO prospectus he states the following:

  • "Facebook was not originally created to be a company. It was built to accomplish a social mission."
  • "We think it’s important that everyone who invests in Facebook understands what this mission means to us, how we make decisions and why we do the things we do."
  • "We don’t build services to make money; we make money to build better services."
  • "We don’t wake up in the morning with the primary goal of making money"
  • "We’re going public for our employees and our investors."[iii]

On page 20 of the filing, it goes on "Mr. Zuckerberg has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. In addition,  Mr. Zuckerberg has the ability to control the management and affairs of our company as a result of his position as our CEO  and his ability to control the election of our directors. Additionally, in the event that Mr. Zuckerberg controls our company at  the time of his death, control may be transferred to a person or entity that he designates as his successor." On page 31, the filing reads, "We have elected to take advantage of the “controlled company” exemption to the corporate governance rules for publicly listed companies. Because we qualify as a “controlled company” under the corporate governance rules for publicly-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function."

It’s Zuck’s world and we’re just friends in it.  Make no mistake, this is Mark Zuckerberg’s company and he will do with it how he pleases.  And so far he has, an example being the acquisition of photo-sharing application Instagram for $1 billion in March, without any input from the board of directors.  From a corporate governance standpoint, this clearly results in low marks.

While our focus at Aurum is multi-asset and multi-manager portfolio solutions for our clients, we turn to the bible of value investing, Graham & Dodd’s Security Analysis, as a guide for stock analysis. Now a value approach is not necessarily the best way to approach a rapid growth company, yet the book’s insights provide strong context for thinking about securities:

“An investment is one which upon thorough analysis, promises safety of principal and a satisfactory return.  Operations not meeting these requirements are speculative.”

“The price is frequently an essential element so that a stock may have investment merit at one price level but not at another level… The safety sought in investment is not absolute or complete; the word means, rather, protection against loss under all normal or reasonably likely conditions or variations… A safe stock is one which holds every prospect of being worth the price paid except under quite unlikely contingencies.  Where study and experience indicate that an appreciable chance of loss must be recognized and allowed for, we have a speculative situation.”[iv]

Given the relative valuations of Facebook to its peers in the Technology industry, the price assumes that the future falls into place quite well.  There is certainly not safety in its price at the $100 billion level.  It unequivocally falls into the speculation camp from a valuation perspective.   Investors should change the question around about buying it, and really ask, should I sell it short (and profit from the price going down)?  Of course, shorting on valuation alone is not an approach most professional investment managers prefer.

And it is also easy to consider situations that could result in an impairment of capital at a $100 billion valuation.  Facebook could continue struggling to implement a strong mobile app that drives revenue, it could become disrupted by another technology, or users could just become creeped out with the ads (because big brother’s watching) or general disenchantment with the experience.

Of course it is easy to envision investors clamoring for shares to send a pop of 20% or more in the short term like recent internet IPOs.  And just as an object that is in motion tends to stay in motion, momentum in stock prices can go unpredictably higher.  In Asia, Dealbook reported that the offering is more than 25 times oversubscribed.[v]  CNNMoney also reported, “Facebook’s IPO has been one of the hottest topics of conversation among seniors living in a retirement community in Boynton, Beach FL, said 79-year old resident Alvan Sweet.”[vi]  And remember, a movie was made about this company; popularity can go a long way.

Last year, a few internet companies did quite well on the open, while other did not fare so well.

Internet IPOs in 2011[vii]

A worry is about the social internet peer group and its fledging performance as public companies.  LinkedIn was an exception after a -36% drawdown during its first year.


Longer-term factors and execution of the business strategy will ultimately determine the durability of gains or impairment of the stock.  From a technical standpoint, buying pressure could come about if Facebook is added to the S&P 500 or NASDAQ 100 index, as passive investors will be forced to purchase the company.  Selling pressure might come from insiders whose stock restriction lifts (within six to twelve months).   

Hopefully this primer serves as an information source for those buying (or selling) this new issue.


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Important Disclosures

This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or warranty with respect to the accuracy or completeness of this material. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein.

Estimates of future performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Aurum Wealth Management Group and/or Aurum Advisory Services does not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein.  This material should not be viewed as advice or recommendations with respect to asset allocation, any particular investment, or any tax advice.  Persons should not use any information contained herein or linked presentations as a primary reason for investment or tax decisions.



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