Advisers telling clients to avoid 'most hyped IPO in history'

Say Facebook shares are vastly overpriced; 'a marketing textbook'

May 18, 2012 @ 3:11 pm

By Jeff Benjamin

With the hype surrounding Friday's public stock offering by Facebook Inc. Ticker:(FB) reaching a fever pitch, a lot of financial advisers have resorted to basic math to give their clients some perspective on the social-networking giant.

“With over 800 million users, it would be pretty hard to argue that Facebook is not a good business, and we believe they have a good management team," said Scott Schermerhorn, chief investment officer of Granite Investment Advisors, a $550 million advisory firm. "But the price is where we fall down on this stock.”

Like a lot of advisers recently, Mr. Schermerhorn said many of his clients have been inquiring about investing in Facebook, which began trading at $38 a share, giving the company a $110 billion market cap.

With an IPO price equal to more than 105 times earnings and 25 times revenues, Mr. Schermerhorn said he tells clients to wait a few months for the initial hysteria to die down.

“I've heard arguments that normal valuation metrics don't apply here, and when I hear that, it reminds me of the late 1990s,” he said. “The reality is, Facebook should grow pretty rapidly, but if you're buying something at 105 times earnings — when the good news is already priced in — you have to be expecting better than the good news.”

The price of Facebook shares, which began trading at 11 a.m. ET on Friday and soon went up, ultimately closed flat for the day.

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George Feiger, chief executive of Contango Capital Advisors, a $3.3 billion trust company and advisory firm, said he wouldn't buy Facebook and he is doing everything in his power to prevent his clients from buying the stock at current levels.

“I have no idea what the valuation should be," he said. "But I know this is the most hyped IPO in history and insiders have been selling massive amounts of stock.”

In addition to unprecedented levels of pre-market trading between Facebook insiders and private investors over the past several months, Mr. Feiger said investors at this point should be aware of the system they are buying into.

“You're dealing with something where the purpose of the exercise is to let people who know more about it than you do to cash out, but investors still haven't caught on to that,” he said. “It's a masterpiece of hype and investors have been manipulated to a level that's unbelievable. This thing should be written as a marketing textbook, and someone should get a medal for the way it was conducted. This is the way political campaigns are done.”

The irony is that mutual fund flow data show that investors have pulled more than $166 billion out of equity funds since the market bottomed in March 2009, despite the S&P's gaining more than 100%. “It's crazy the way investors are pulling money out of equity funds, but they want to chase Facebook,” Mr. Schermerhorn said.

Recent market volatility — particularly the performance of social-media stocks — also should worry investors. “The upside on this type of stock in the short to medium term is relatively limited, but the risk comes from the market as a whole,” said Josef Schuster, chief executive of IPOX Capital LLC. “If you see what's been happening to the overall market lately, it's really time to be defensive, and Facebook is not a defensive stock. You don't buy IPOs in this environment.”

For some advisers, dealing with the Facebook issue is just the latest steop in a steady process of bringing clients back down to reality. “I've had some calls from clients about this, and my suggestion is that we wait because I think it's overpriced,” said Theodore Feight, owner of Creative Financial Design.

Mr. Feight is sticking to his strategy of avoiding stocks at their IPO, but he is reminded of some conversations he had with clients back in 2000 when he resisted buying IPO shares of Krispy Kreme Doughnuts Inc. Ticker:(KKD).

“I had a couple of clients who really wanted Krispy Kreme and they gave me grief about it for a few years,” he said.

The retail investor interest in Facebook stock is “record level,” according to Paul Schatz, president of Heritage Capital LLC. That doesn't mean he's willing to budge on his strict “no IPOs” rule.

“This is a huge retail deal, but I think it's way too high-profile, there's too much risk in it, and I don't think the reward is there,” he said. “I tell my clients who really want it to at least wait a month or so for some selling by insiders."

In the meantime, Mr. Schatz won't be buying. "Personally, I couldn't have less interest in Facebook's stock.”

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