Discuss as:

Facebook offers plenty of reasons not to like its shares

Anyone looking for a reason NOT to invest in the most heavily hyped IPO of the decade need look no further than page 11 of the company's prospectus, filed with federal regulators Wednesday.

There, in what one of our colleagues describes as "the good parts," the company begins a recitation of "risk factors" that runs for some 20 pages.

Some of these are standard boilerplate ("Our business is highly competitive").

But others represent what another colleague describes as "the hopes and fears of Facebook, in a nutshell."

To wit:

  • The company got 12 percent of its revenues last year -- $444 million! -- from online gaming company Zynga. That is an awful lot of "Words with Friends."
  • The company is involved in "numerous class action lawsuits and other litigation matters." As anyone who saw "The Social Network" is well aware.
  • Facebook is subject to "complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, and other matters." Come on now, you know you love the Timeline.
  • Payment transactions on "the Facebook Platform" could be subject to additional regulations.
  • Possibly unfavorable media coverage.
  • Potential bugs in the software.
  • Potential cashouts when "lockup" periods end, beginning three months after the IPO.
  • The unusual power of founder Mark Zuckerberg, who owns the biggest chunk of Facebook and will retain a majority of its voting shares.

One risk factor not mentioned: Only an anointed few will even get a chance to buy Facebook shares at the IPO price. Most of the investing public will have to wait until after shares are allocated, mostly to favored customers of the underwriting brokerages.

If  Facebook follows the pattern of most heavily hyped Internet stocks, the price will be far higher on the secondary market after the expected first-day "pop."

In perhaps the ultimate Facebook status update, the company said it plans to raise $5 billion in what would be one of the biggest ever initial public offerings of stock.

The offering did not specify a total value for the company, but analysts have said the range could be up to $100 billion, which would be a record, said Peter Adriaens, professor of entrepreneurship at the University of Michigan’s Zell Lurie Institute.

Facebook’s workforce doubled in 2011 to some 3,000 employees, and the company said,  “We expect this growth to continue for the foreseeable future. We have also made and intend to make acquisitions with the primary objective of adding software engineers, product designers, and other personnel with certain technology expertise. While our organization is growing rapidly, we are focused on increasing our talent base at a rate that allows us to preserve our culture.”

Preserving the culture and not growing too fast has been a concern for Zuckerberg for some time, which is part of the reason he’s been reluctant to go public until recently.

In a letter from the CEO included in the filing he said: “Facebook was not originally created to be a company. It was built to accomplish a social mission — to make the world more open and connected.”

To that end, one of the risk factors foreseen in the filing is how growth will impact the corporate culture. “As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance.”

Another issue for the social networking company is restrictions on getting into China, which could hamper its growth, Adriaens said.

Facebook has zero penetration into China, according to the filing, because of “substantial legal and regulatory complexities.” Going further, it continued, “If we fail to deploy or manage our operations in international markets successfully, our business may suffer.”

The company also hoping the Obama administration will rethink tax policy changes on international profits: “Certain changes to U.S. tax laws, including limitations on the ability to defer U.S. taxation on earnings outside of the United States until those earnings are repatriated to the United States,” the filing stated, could end up increasing Facebook’s tax burden.

But continued growth in advertising from companies looking to reach Facebook users overall could take the sting out of such changes. Ad revenues jumped 42 percent last year and the average price per ad rose 18 percent.

Going forward, Adriaens expects more gaming companies to want to leverage Facebook’s platform, but he said one of the most encouraging signs of Facebook’s potential is its cost structure. The cost of sales, advertising, and research and development, essentially the key expenses of doing business, is actually declining. As a percent of overall sales in 2011, cost and expenses dropped to about 52 percent, compared to more than 60 percent in the previous year.

“That was Groupon’s biggest problem,” referring to the online coupon company that went public last year and has seen its stock falter. “If Facebook can keep costs down that’s good.” 



Facebook files to be just 'FB' in IPO

Would you buy Facebook shares?

Like or unlike? Click to comment