Going Gaga: Why Facebook's IPO may crown an epic market "top"

Facebook: Photo: AP

BANGALORE, India, May 17, 2012 — A global frenzy buzzes now like so many angry bumblebees. 

At any moment, a company started in a dormitory just eight years ago will sell promoted common shares to the investing public and become the hottest technology diva ever.

Unusual animal movements have preceded extraordinary natural disasters—might they also mark onset of man-made financial mayhem?

Hundreds of millions of us like using Facebook. At first blush the features and benefits seem a compelling bargain. But as far as investors in this offering are concerned, are valuation levels for Facebook’s Class A common shares supported by realistic hope or by artful hype?

About the time Facebook was founded, Google achieved its historic initial public offering. Comparisons between Facebook and Google are certainly worth considering.

In 2011, Facebook earned revenues of $3,711 million and net income for its common shareholders of $668 million. Growth from 2010 occurred at torrid rates—revenue was up 88 percent while net income nearly tracked at 80 percent during a period when so many other corporations foundered.

In contrast, Google in 2011 earned revenues of $37,905 million and net income of $9,737 million. Granted, Google’s growth in revenues was “just” 29 percent and net income “only” grew at 14 percent.

Is it reasonable for the market to value newcomer Facebook at roughly 50 percent of “venerable” Google when Facebook’s revenues are just 10 percent of Google’s and when Facebook’s attributable net income is only 7 percent of Google’s?

Investors do regularly fall victim to manic delusion, especially when the crowd spots a seemingly sure path to easy winnings. What truths will eventually shape results for investors in the Facebook phenomenon? Useful insights can be obtained by evaluating precedents and considering history.

The Facebook offering is likely to be heavily over-subscribed, so the lucky few who receive an allocation of shares and then flip their holdings to followers will score a quick hit. But I would remind those lining up to play in Facebook of the fate that befell investors in another promoted interest of “can’t miss” common securities.

In February 2007,  Steve Schwarzman celebrated his 60th birthday in a style so lavish that even the jaded denizens of New York found it jarring, just before he offered investors a heavily promoted chance to share, somewhat, in the fortunes of his boutique. Scant weeks later, the abrupt demise of a comparatively minor fund not even run by Blackstone pricked the bubble of the most recent gilded age. 

Even in the ensuing turmoil, underwriters were able to price the Blackstone Group offering on a Thursday after the close, back in June 2007. For a brief moment, Blackstone’s common units traded Friday above the initial offered price of $31 per unit. Since that June weekend, Blackstone common units have traded mostly under water; they closed on 16 May 2012 at $12.22 per unit, down a cumulative 61 percent in nominal dollar terms in just under five years.

The jury remains out on the merits of having purchased Blackstone units as that marquee firm of world class professionals might ultimately get sold for a fancy price to a strategic acquirer. But is it reasonable to conclude that loyal, long-term investors in the Blackstone offering have been fairly compensated for the risks they assumed through the continuing global crisis that once again is gathering force?

Another moment in history worth considering is the first calendar quarter of the year 2000, when the “new economy” bubble was popping. In February 2000, the founder of Kozmo.com (a company organized to deliver products for free on an hour’s notice) explained in an interview why that shooting star was a path to potential riches.

“We’ve got killer aps, man. Killer aps!” Joseph Park sagely opined.

Case closed, or so he thought, just months before that theoretically mighty mouse finally bit the dust.

Back in 2000, catchy company names and enthusiasm of inexperienced youths were catalysts for investor pain, just as dining on expensive frosting leads to heartburn. 

Reaching back to a time before personal computers, for decades boys at the Horace Mann School in Manhattan used to savor the wafting fumes that emanated from a plant owned by The Stella D’Oro Company—famed maker of breadsticks, cookies and fudge.

For reasons ranging from bad management, to union intransigence, to the soaring cost of trying to do business inside one of the most expensive cities in America, the Stella D’Oro plant just south of the Horace Mann campus is no more. This trigger of joy for children of all ages was shuttered in 2009.

Another iconic company — The Hostess Baking Company — followed in the footsteps of that Stella D’Oro plant at the beginning of 2012.

Food purists among us and the First Lady may very well cheer the demise of a purveyor of such guilty pleasures. However, this finicky eater proudly admits  to savoring American cheese, topped with cold iceberg lettuce, in between two toasted slices of Wonder Bread that are smothered in mayonnaise (if not Miracle Whip). Truly yummy, and even better if followed up by some Twinkies, washed down with cold chocolate milk!

A diet of insubstantial snacks will never nourish a growing child. Nor will buying highly priced securities at the top of a cycle build wealth just as tectonic plates threaten to shake the foundation of the global system.

Companies that sell products for hard cash have fast been disappearing inside the United States, Europe and Japan. Is it finally past time to admit that leaders and central bankers have no effective tricks left to save the advanced world from painful re-calibration of productive capacity, income and wealth that seems to me long overdue?

Historians and economists still do not fully agree concerning the primary causes and ultimate cures for the First Great Depression. But I believe there are important, discordant and alarming similarities between 1933 and 2012.

In America, the economic collapse that started in 1929 and took deeper root in 1933 followed a long period of unchecked financial speculation. Inside our country and many others, the supply of labor suddenly exceeded demand. But back then, government was much smaller, America’s international obligations were miniscule and our total national debt was far less than it has now grown to become.

Eighty-nine years ago, the Marx Brothers starred in Duck Soup, a film that opened to mixed reviews and subsequently has won great critical acclaim. Back then, the imperious Gloria Teasdale overtly pulled the strings of Rufus T. Firefly, the puppet President she installed as leader of Fredonia. 

In contrast, we do not know with any precision in 2012 who exactly controls the levers of power behind leaders who theoretically serve the best interests of citizens in the large, “advanced” and indebted nations of Japan, Europe and North America. 

Will the vaunted Facebook initial offering define an even more painful market top in the epicenter of a “Grand Convulsion”?

I enjoy using the site but must confess that Facebook’s main attraction is found in words placed just under the exhortation to sign up:

“It’s free and always will be.”

Now and for at least 13 long years, a growing share of the world’s population has lost itself behind much smaller screens while absorbed in solitary interaction and contemplation, connected and so very disconnected like digital Schrodinger cats.

In distinct contrast, even poor Americans scraped up the necessary cash to drown some of their sorrows at the cinema in 1933.

Most revenues earned by Facebook are, by definition, derivative - they depend upon people like us to enter information that advertisers will value. Furthermore, companies must choose to deploy scarce advertising budgets towards social media and away from other formats.

As in the case of Google, early growth is likely by taking share from old horses such as print, network television, cable television and radio.

Should investors care that General Motors (another victim of modern times) announced it will cease advertising via Facebook?

Call me old-fashioned, but I believe the Facebook offering does come close to a market top.

Companies that rely upon humans to give away valuable information in exchange for ephemeral pleasures may prove, in the end, to rest on ground even less substantial than Wonder Bread and Twinkies.

Investors should allocate scarce capital to attractively priced companies with substance, politicians should stop playing the public for fools and all of us should resist the allure of dancing the hustle before divas!



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Charles Ortel

Charles Ortel became a lapsed member of the silent majority in August 2007 when he began alerting the public to dangers posed by structural changes in the global economy. Since then, Charles has appeared in the print, radio and television media with increasing frequency. Brass Tacks will attempt to offer non-partisan perspective on factors contributing to the unresolved, burgeoning crisis and discuss potential solutions. Graduated from Horace Mann School, Yale College and Harvard Business School, Charles tries to learn each day.  

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