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Facebook IPO: Social not-working

  • 1 June 2012

In the past, in articles such as Fear of the new, we have highlighted our misgivings about initial public offerings (IPOs) in general, and particularly about those of new tech businesses such as social networking sites and search engines.

While we would not want to labour the point, the recent Facebook floatation has highlighted some of these misgivings.

When it comes to new tech companies, it's easy to think about the handful of successes, such as Amazon and Google, to the exclusion of the many dozens of businesses that failed. In investment, how can it be right to focus only on the few that have succeeded beyond anyone's wildest expectations? Everybody wants to find that diamond in the rough but unfortunately it's unlikely.

Of course Facebook has shown impressive growth in recent years but does that mean it can continue at the same rate? This is a company that, in the space of just eight years, has gone from nothing to capturing over 900 million users but does that mean it is a wonderful business or that, if a competitor gets its product right, it can take an enormous amount of market share? In a world of Tech 2.0, what is to stop Facebook 2.0?

Five years ago, it was tough to forecast how successful Facebook would be, so why is its success now being mapped out as a straight line into the future? That is doubly questionable given Facebook's valuation, with some analysts forecasting the company as being on a price/earning ratio of 30x in five years' time. You can buy Apple or Google on about a third of that today.

What was it that made everyone so positive? It's worth trying to stand back and take some of the emotion out of proceedings and just focus on the numbers. Pretend it is not Facebook but ‘Company A' and then look at all the businesses over the last dozen years that floated with these kinds of valuations and forecasts. How many of them turned out to be winners? As we said earlier – a handful. It is a classic triumph of heart over head.

We are back to the two basic human emotions of fear and greed. At some point during the tech bubble at the turn of the century, the technology sector suddenly went from being an area where a minority of investors made lots of money to one where the majority of investors made lots of money. That was greed. But when something becomes such a big part of the market and you are not involved, it then flips from greed to fear.

Have we reached that point again?

Continue reading…

 

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