As Investors Await Facebook IPO, Social-Networking Companies Look to Cash In With Blockbuster IPOs
It appears investors will have to wait until the first quarter of 2012 to get their hands on shares of Facebook--that is unless they are willing to pony up the large amount of cash required to buy shares of Zuckerberg's $100 billion dollar company on SharesPost.com or SecondMarket.com. But why should investors have to wait another nine months to throw their kids college fund away on the stock of a hot social-networking company trading at a suicidally high price/sales ratio? Thankfully, LinkedIn (Ticker: LNKD) stepped-in to quench the market's thirst on May 18th when it "sold 7.84 million shares for $45 each, a higher price than [even] the company was expecting...earlier [that] week." (Selyukh)In case you're unfamiliar with the company, LinkedIn is, according to the company website "the world's largest professional network on the Internet with more than 100 million members in over 200 countries [and generates] revenues... from user subscriptions, advertising sales and hiring solutions."(LinkedIn.com) Basically, it is Facebook for business people and professionals.
While its growth has been meteoric, the company is overvalued by virtually every meaningful metric one can conjure-up. It's price to earnings ratio is a mind-boggling 595, it's price to book ratio is close to 71, and it's price to sales ratio is 31. (source: Morningstar) By comparison, Google's p/e is 13.2, its p/b is 3.5, and its p/s is 5.5. Allow me to reiterate: the price to book value of LinkedIn is 71. That means the company is trading for seventy-one times the net asset value of the business (assets minus liabilities). Ok, so its overvalued like a hot.com stock in 2000. That's not the point. The point is that everyone knew it was overvalued before it began trading and people bought it anyway. On its first day of trading "the stock opened at $83 and quickly rose above $90, where it stayed for most for most of the morning [before] hit[ting] a high of $122.70 in late morning trading"--the IPO price was $45. (Pepitone)The price performance of the stock on its first day of trading reflects investors' appetite for companies with huge potential for future growth. LinkedIn is one of those companies, as are Zynga, Groupon, and, the grandaddy of them all, Facebook. If investors missed LinkedIn's IPO that's ok because on June 2 Groupon filed to go public in an offering that could fetch $3 billion. Groupon, which has grown revenue from a mere $94 million in 2008 to over $713 million last year and which has already racked up close to $645 million in revenue this year, gives its 83 million subscribers the opportunity to buy coupons from local restaurants, bars, and other businesses at a substantial discount. For instance, a subscriber might pay $10 dollars at groupon.com for a coupon worth $20 in food at a local eatery. Though the business model is sound, the rate at which the company is expanding is costing money--a lot of money. Although Groupon pulled in $713 million in revenue last year, it actually "posted a loss of $456.3 million...nearly half of which was acquisition related." (Munarriz) Also noteworthy is the fact that "the amount that Groupon reports as revenue is the full amount of the prepaid deals...[of which] Groupon kept just 39% last year." (Munarriz) Furthermore, only about 25% of Groupon's subscribers have ever actually purchased a coupon from the company.But at the end of the day, no one can deny that the company is growing at an unprecedented rate.
It now boasts 57,000 participating merchants; up from 212 two years ago. Even more astonishing, the number of people subscribing to Groupon has risen from 152,000 in 2009 to over 83 million currently. (Solin) This kind of growth should attract enough investors to drive Groupon's stock through the roof in the first few days it is available to the public. Never mind those who say that Groupon is not 'a good investment' because it is 'overvalued.' Of course it's overvalued--so was LinkedIn when it went public. The flood of irrationality and exuberance that will likely surround Groupon's IPO will almost certainly wash away any trace of reason or prudence--at least for a few days.Traders should take advantage of the opportunity: the idea is to make money, not to debate the long term prospects of a company that sells restaurant coupons. When the stock becomes available to the public, traders should buy it in the morning and watch it climb. After it goes up the first day, the disciplined trader will sell it immediately. The next step is to wait until reality kicks in and people begin to sell the overvalued shares. At this point the savvy trader will purchase long puts (contracts that allow traders to sell 100 share lots of stock at a specified price) on the company's stock in the options market. This will allow the trader to profit from a decline in Groupon's shares. In this way, traders can make money on the way up, and, if the timing is right, on the way down. Additionally, if the goal is fast profits, it will be wise to ignore those who say that the average person has no chance of getting into Groupon at the IPO price. This is true (typically, only the wealthy and the well-connected get a piece of the IPO at the actual IPO price) but keep this in mind: the insiders got LinkedIn for $45. It was $83 by the time the average Joe got a crack at it. But it was at $122.70 a few hours later. No one should complain about getting in at $83 and selling at $122--even if someone else got it for $45. The trick is to be disciplined and bail-out after the first-day bonanza.Although I believe that even the 'small guy' has a good chance of making money from the IPOs of hot social-networking companies, the average investor can certainly be forgiven for being skeptical. After all, only a privileged few are likely to get Groupon, Zynga, or Facebook stock at or near the actual IPO price (the rest of us will just have to see what the stocks open at). Even if one did manage to get some shares at a price that is not too inflated, the first few days of trading in these issues are likely to be a gut-wrenching roller-coaster ride that will test the discipline and resolve of even the most level-headed trader. However, as a recent article in the Wall Street Journal ("Is His Company Worth $1000 Billion?" by Shayndi Raice) makes clear, social-networking companies have huge growth prospects. One venture capitalist interviewed by the Journal estimates Facebook's revenue will be around $20 billion per year by 2015. Investors are excited about these businesses and no matter how many analysts and commentators come out and say social-networking companies are overvalued, one simple fact remains: these stocks are extremely likely to go up (way up) on IPO day, and their prices are likely to stay inflated--at least for a little while.With so many of these companies going public this year, traders will miss a huge opportunity if they allow their fear of volatility to keep them on the sidelines. Let me reiterate that I do believe these companies are overvalued by almost any metric one wishes to use. But that won't keep investors out of the market when the companies go public, and shouts of "be rational for god's sake!!" won't keep the stocks from going up. In short: if traders want to make money, they need to be in these trades one way or another. Fortunately for the faint-of-heart (read: the rational and the intelligent), there is a good way to mitigate the risks associated with hot IPOs. First Trust US IPO Index ETF (Ticker: FPX) carries a surprisingly low expense ratio (just.60%) and it even pays a dividend (it yields.86%). To be sure, it "offer[s] only limited exposure to the most sought-after tech IPOs and their hoped-for first-day-gains...[but] assets are spread across 25 to 100 diverse companies, providing a cushion from the kind of share-price fallback that LinkedIn experienced after its first-day pop." (Hogan L14) Additionally, buying shares of this ETF puts a small-time investor's money in a pool of assets that is big enough to carry some weight on IPO day. What does that mean? It means that when these companies do go public, Mr. Average Joe is likely to get some shares at the actual IPO price instead of the opening price. Personally, I would not want to own this ETF as part of my long-term portfolio because some years are better for IPOs than others. But with so many hot social-networking companies going public in the next two years, shares of FPX could double by 2013. Investors might miss the 300% and 400% short-term gains, but with FPX, at least they'll get a piece of them.Works CitedHogan, Mike. "The Little Guy's Guide to the IPO Frenzy" Barron's. 11 July, 2011: L14-L15.Munarriz, Rick. (2011, June 3). 3 Surprises in Groupon's Prospectus. TheMotleyFool. Retrieved July 10, 2011,Pepitone, Julianne. (2011, May 19). LinkedIn Stock More Than Doubles in IPO. CNNMoney. Retrieved July 10, 2011
Raice, Shayndi. "Is His Company Worth $100 Billion?." The Wall Street Journal. 14 July, 2011: B1-B2.Selyukh, A. and Clare Baldwin. (2011, May 18). LinkedIn IPO Prices at $45 Per Share, But Risks Real. Reuters. Retrieved July 11, 2011Solin, Daniel. (2011, June 16). Why I Won't Be Buying Groupon Stock. USNewsMoney. Retrieved July 11, 2011Information on FPX through Morningstar: http://quote.morningstar.com/ETF/f.aspx?t=fpx#
While its growth has been meteoric, the company is overvalued by virtually every meaningful metric one can conjure-up. It's price to earnings ratio is a mind-boggling 595, it's price to book ratio is close to 71, and it's price to sales ratio is 31. (source: Morningstar) By comparison, Google's p/e is 13.2, its p/b is 3.5, and its p/s is 5.5. Allow me to reiterate: the price to book value of LinkedIn is 71. That means the company is trading for seventy-one times the net asset value of the business (assets minus liabilities). Ok, so its overvalued like a hot.com stock in 2000. That's not the point. The point is that everyone knew it was overvalued before it began trading and people bought it anyway. On its first day of trading "the stock opened at $83 and quickly rose above $90, where it stayed for most for most of the morning [before] hit[ting] a high of $122.70 in late morning trading"--the IPO price was $45. (Pepitone)The price performance of the stock on its first day of trading reflects investors' appetite for companies with huge potential for future growth. LinkedIn is one of those companies, as are Zynga, Groupon, and, the grandaddy of them all, Facebook. If investors missed LinkedIn's IPO that's ok because on June 2 Groupon filed to go public in an offering that could fetch $3 billion. Groupon, which has grown revenue from a mere $94 million in 2008 to over $713 million last year and which has already racked up close to $645 million in revenue this year, gives its 83 million subscribers the opportunity to buy coupons from local restaurants, bars, and other businesses at a substantial discount. For instance, a subscriber might pay $10 dollars at groupon.com for a coupon worth $20 in food at a local eatery. Though the business model is sound, the rate at which the company is expanding is costing money--a lot of money. Although Groupon pulled in $713 million in revenue last year, it actually "posted a loss of $456.3 million...nearly half of which was acquisition related." (Munarriz) Also noteworthy is the fact that "the amount that Groupon reports as revenue is the full amount of the prepaid deals...[of which] Groupon kept just 39% last year." (Munarriz) Furthermore, only about 25% of Groupon's subscribers have ever actually purchased a coupon from the company.But at the end of the day, no one can deny that the company is growing at an unprecedented rate.
It now boasts 57,000 participating merchants; up from 212 two years ago. Even more astonishing, the number of people subscribing to Groupon has risen from 152,000 in 2009 to over 83 million currently. (Solin) This kind of growth should attract enough investors to drive Groupon's stock through the roof in the first few days it is available to the public. Never mind those who say that Groupon is not 'a good investment' because it is 'overvalued.' Of course it's overvalued--so was LinkedIn when it went public. The flood of irrationality and exuberance that will likely surround Groupon's IPO will almost certainly wash away any trace of reason or prudence--at least for a few days.Traders should take advantage of the opportunity: the idea is to make money, not to debate the long term prospects of a company that sells restaurant coupons. When the stock becomes available to the public, traders should buy it in the morning and watch it climb. After it goes up the first day, the disciplined trader will sell it immediately. The next step is to wait until reality kicks in and people begin to sell the overvalued shares. At this point the savvy trader will purchase long puts (contracts that allow traders to sell 100 share lots of stock at a specified price) on the company's stock in the options market. This will allow the trader to profit from a decline in Groupon's shares. In this way, traders can make money on the way up, and, if the timing is right, on the way down. Additionally, if the goal is fast profits, it will be wise to ignore those who say that the average person has no chance of getting into Groupon at the IPO price. This is true (typically, only the wealthy and the well-connected get a piece of the IPO at the actual IPO price) but keep this in mind: the insiders got LinkedIn for $45. It was $83 by the time the average Joe got a crack at it. But it was at $122.70 a few hours later. No one should complain about getting in at $83 and selling at $122--even if someone else got it for $45. The trick is to be disciplined and bail-out after the first-day bonanza.Although I believe that even the 'small guy' has a good chance of making money from the IPOs of hot social-networking companies, the average investor can certainly be forgiven for being skeptical. After all, only a privileged few are likely to get Groupon, Zynga, or Facebook stock at or near the actual IPO price (the rest of us will just have to see what the stocks open at). Even if one did manage to get some shares at a price that is not too inflated, the first few days of trading in these issues are likely to be a gut-wrenching roller-coaster ride that will test the discipline and resolve of even the most level-headed trader. However, as a recent article in the Wall Street Journal ("Is His Company Worth $1000 Billion?" by Shayndi Raice) makes clear, social-networking companies have huge growth prospects. One venture capitalist interviewed by the Journal estimates Facebook's revenue will be around $20 billion per year by 2015. Investors are excited about these businesses and no matter how many analysts and commentators come out and say social-networking companies are overvalued, one simple fact remains: these stocks are extremely likely to go up (way up) on IPO day, and their prices are likely to stay inflated--at least for a little while.With so many of these companies going public this year, traders will miss a huge opportunity if they allow their fear of volatility to keep them on the sidelines. Let me reiterate that I do believe these companies are overvalued by almost any metric one wishes to use. But that won't keep investors out of the market when the companies go public, and shouts of "be rational for god's sake!!" won't keep the stocks from going up. In short: if traders want to make money, they need to be in these trades one way or another. Fortunately for the faint-of-heart (read: the rational and the intelligent), there is a good way to mitigate the risks associated with hot IPOs. First Trust US IPO Index ETF (Ticker: FPX) carries a surprisingly low expense ratio (just.60%) and it even pays a dividend (it yields.86%). To be sure, it "offer[s] only limited exposure to the most sought-after tech IPOs and their hoped-for first-day-gains...[but] assets are spread across 25 to 100 diverse companies, providing a cushion from the kind of share-price fallback that LinkedIn experienced after its first-day pop." (Hogan L14) Additionally, buying shares of this ETF puts a small-time investor's money in a pool of assets that is big enough to carry some weight on IPO day. What does that mean? It means that when these companies do go public, Mr. Average Joe is likely to get some shares at the actual IPO price instead of the opening price. Personally, I would not want to own this ETF as part of my long-term portfolio because some years are better for IPOs than others. But with so many hot social-networking companies going public in the next two years, shares of FPX could double by 2013. Investors might miss the 300% and 400% short-term gains, but with FPX, at least they'll get a piece of them.Works CitedHogan, Mike. "The Little Guy's Guide to the IPO Frenzy" Barron's. 11 July, 2011: L14-L15.Munarriz, Rick. (2011, June 3). 3 Surprises in Groupon's Prospectus. TheMotleyFool. Retrieved July 10, 2011,Pepitone, Julianne. (2011, May 19). LinkedIn Stock More Than Doubles in IPO. CNNMoney. Retrieved July 10, 2011
Raice, Shayndi. "Is His Company Worth $100 Billion?." The Wall Street Journal. 14 July, 2011: B1-B2.Selyukh, A. and Clare Baldwin. (2011, May 18). LinkedIn IPO Prices at $45 Per Share, But Risks Real. Reuters. Retrieved July 11, 2011Solin, Daniel. (2011, June 16). Why I Won't Be Buying Groupon Stock. USNewsMoney. Retrieved July 11, 2011Information on FPX through Morningstar: http://quote.morningstar.com/ETF/f.aspx?t=fpx#
