How to Trade the Facebook IPO

Friday 18 May looks set to be the date whereby we see the most eagerly anticipated IPO launch in recent memory.

Facebook, the social media giant founded in 2004 that has taken the world by storm and changed the way people socialise online, lists as a public company on Friday and City Index spread bettors and CFD traders will be able to trade Facebook shares immediately.

Facebook Valuation
Facebook’s IPO could set a valuation on the company of over $100bn if the top end of its current price range – $34 to $38 – is met.

However, IPOs can be extremely unpredictable and difficult to trade. The hysteria surrounding Facebook’s IPO could make this one of the most difficult to ascertain how the share price may perform after the initial flotation.

So let’s look at what could happen.

What could happen?
As mentioned above, IPOs can be particularly volatile in the first few weeks of a new found public life, as investors attempt to strike a medium between valuation, supply, demand and digesting the relative successes and failures of the initial offering (a factor which should not be underestimated).

Facebook’s IPO could, however, be somewhat different by the mere scale of its popularity. In terms of market IPO celebrity status, Facebook is David Beckham. Whilst some investors could just find themselves fighting to jump on the Facebook bandwagon and grab some form of share of the company, even at a high cost, this can cloud true market sentiment until the hysteria somewhat dies down.

Case Study: LinkedIn 
Looking at previous headline IPOs, the share price performance after the initial hysteria has not been fantastic.

Focussing on a sector peer to the social networking site, LinkedIn, its shares price more than doubled on the first day of its IPO, which incidentally launched exactly 1 year and 1 day earlier to Facebook’s own IPO, from a price of $45 to close at $94.25, which is some first day!

However, the hysteria soon mellowed and the firm’s share price subsequently lost a third of its value within the next month. A month later, the share price recovered back to its $94 first day close.

Case Study: Google

Looking at Google’s IPO in 2004, the year when Facebook was actually founded, its own share price doubled within two months and never looked back; hitting a peak of $747 after just three years as a publicly listed company having launched at $85.

Case Study: Glencore
Let’s look at another IPO, different sector to Facebook but of equal headline popularity recently, Glencore.

A key element with Glencore’s IPO, and where it differs somewhat from LinkedIn – but perhaps where some elements of similarity, albeit small, resides with Facebook – is down to valuation concerns.

There were big question marks over whether the Glencore IPO valuation was ‘top heavy’. Indeed, its first day as a public entity saw its share price close unchanged from its IPO price but then subsequently falling 15% within a month and 35% within 3 months, albeit within the broader context of existing heavy global market falls.

The lesson here is IPOs are never a smooth process and can be highly volatile regardless of whether you are going long or selling short.

The above is not to say however that Facebook is a company that warrants such a huge valuation given its popularity and model.

Demand for Facebook Shares
At the end of March 2012, the company had over 900m active users each month – half of which were connecting via their mobiles – with approximately 80% of its users coming from outside of the US; a huge user base with great geographic diversity.

What’s more, the product is extremely sticky; with 398m users (44% of total active user base) connecting to Facebook for 6 out of 7 days a week.

Demand for Facebook shares has been extremely high, so much so that the company increased the size of its IPO by almost 25% or 84m shares due to the sheer size of demand.

This demand allowed the company to increase its target pricing range from $28 to $35 per share to $34 to $38 per share (median range increase of 14% to $36).

The increase may well lessen the upward impact on its share price from day 1 but given the fact that many IPOs pricing attempts to launch towards a somewhat conservative price range to allow for upwards momentum to drive share prices higher on the initial offering, this may not make too much of an impact.

Access to buy into the Facebook IPO is likely however to be an exclusive club, reserved for valuable bank clients with the common investor unlikely to be able to buy shares at this stage due to the popularity.

Advertising Concerns
Doubts do remain concerning the long term stability of its price to earnings ratio however, with the IPO set to give it a valuation of more than $100bn.

Concerns remain about whether users are happy to click on advertisements in their social down time in the same way as standard web browsing advertisement click through rates.

In a recent study by Worldstream, it showed that ads on Facebook saw a click through rate (CTR) of just 0.05% compared to 0.4% for standard web display adverts.

Indeed General Motors recently announced it was pulling its advertising from Facebook claiming that its advertisements on Facebook had little effect on consumers.

It’s unlikely other firms will be equally quick to jump ship but the sentiment is certainly one that should not be ignored – General Motors is the third biggest advertiser in the US – particularly for those buying into Facebook at this early stage of its public life.

Could Instability in the Global Markets Have a Negative Effect?
Moreover, the timing of the IPO is not ideal as it comes at a time of huge market uncertainty and slowing global growth where businesses are cutting costs and consumers are hoarding cash, which could make the first quarter performance of Facebook’s share price every bit as important as the first tradable day itself.

Investors have shown strong risk off attitudes and have attempted to recycle funds into safe haven asset classes and stock sectors with Greece edging ever closer to leaving the euro.

Whilst this may not necessarily mean they will turn a blind eye to an investment which they deem has long term value, it is equally a factor that could play a role.

And let’s not forget there are a number of ‘unknowns’ yet that surrounds Facebook that might affect its rate of growth, such as security of personal data and how it will crack into China, which remains off limits to the firm.

So all eyes onto Friday 18 May and to what is likely to be the most fascinating IPO since Google.