Thinking about Facebook IPO: What are some of the Risks?

Consider the risks before you buy Facebook.

If you’re considering purchasing Facebook stock at the IPO – likely in spring or summer 2012 – it’s useful to outline some of the risks in involved in making that trade. Of course, every investment — other than cash or cash equivalents has some risk of loss of principal, but this post is more about outlining the risks with Facebook itself, buying an IPO (initial public offering), and other considerations – which is part of the information, research, and consideration for creating this whole site.

As a trader/investor, I have always dedicated some percentage of my overall stock and option portfolio to what I call “calculated risk”. Maybe you’re comfortable with 5% of your overall investable assets in speculative positions… maybe you’d be fine with less. Of course before you take any risk, consult your own advisors, and make sure that you already have a stable wealth plan in place, and that you’re not just “shooting for the fences”. For me, that risk over time has included trading certain targeted and leveraged ETFs, trading currency at certain times (forex), and deploying a number of options strategies like covered calls, naked and cash-secured puts, and various bull and bear option spreads. I have also on occasion bought speculative biotech companies, penny stocks, and other ‘calculated’ long shots (i.e., including ideas like Allied Irish Bank (ticker: AIBYY), after the selection of two “pillar” banks in Ireland, and trading BP PLC (adr) (ticker: BP) bull call spreads after the Gulf spill, for example.)

CONSIDERING RISK

As we get closer and closer to a Facebook IPO, it makes sense to consider all the factors that would constitute risk variables for early investors, traders, and others to help us decide if we should buy the Facebook IPO? Doing our homework now will help us to know what information we should collect in the coming months. The fear vs. greed balance is muted by the fact that this entire trade must wait — unless you buy the shares now in the private markets — but that’s only available to accredited investors at places like Second Market, Sharespost, and Nyppex. (I have an account at Sharespost — but I do not own any Facebook shares yet.)

FACEBOOK IPO RISKS

1. Overall Market Risk – A highly anticipated IPO may be impervious to a down market, even if the volatility of the markets continues with a slow US real estate recovery, slow job growth in the US, continued debt issues in the European Union, and more. Often the trading in a new issue hot IPO stock can be even more frantic if the market has little in the way of compelling trades and investments for the Wall Street money managers to buy and sell.
2. Industry and Sector Risk – What is the outlook of online business, new tech, Web 2.0/3.0 and more. If you take a look at streaming music site Pandora (ticker: P), and business social media site LinkedIN (ticker: LNKD), you’ll see that the IPO fervor has died off relatively quickly. Of course, so of this was due to the flood of new articles about a new tech bubble, and lofty valuations in new online companies, and the overall pullback in the market as we wondered if Italy, Spain, and others would start to go the way of Greece, Iceland, and Ireland.
3. Individual Company and Stock Risk – Facebook itself, founded in 2004, has a number of direct company risks for the individual. The one most discussed is that the IPO may be a small float ($10B or 10% of the company), with a $100B valuation. Even with a flurry of recent acquisitions, the IPO millionaires (many likely the engineers) could leave the company giving further growth and innovation some challenges. We discussed in an earlier post that buying up other companies now may be just about hiring (buying!) new talented employees. Add to that risk Facebook’s revenue and monetization models — can they really make $125 to $150 per user – which is what is implied? Then there’s the IPO lock-up window where retail investors buy only to have the shares tank in 180 days when the pros can legally exit.
4. Longshot/Black Swan Risk – Even if IPO investors buy the company as a long-term investment and pay too much, it’s possible over time to DCA (dollar-cost-average) a better basis price. (Plan to buy lots in thirds?) But there are always long-shot, black swan-type risks – like market-level (war, terrorism, double-dip recession, Europe, etc.) and stock level (Facebook loses its founder, credibility, user-base, scandal, tech disruption, or other wild-card considerations.) I don’t worry about these things, but I do consider the full scope of RISKS as part of being fully prepared for this, and any investment/trade.

If you’re not a hedge fund or mutual fund, a large broker, or professional money manager, and you’re simply trading/investing with your own funds — maybe you don’t have the benefit of a third-party risk manager or risk committee looking over your shoulder – but you should still consider all the risks before taking speculative trades and investments, even if it’s the much anticipated Facebook IPO. What do you think are the real risks to buying the Facebook IPO? Feel free to leave comments below with your thoughts.

Here's LinkedIN's (ticker: LNKD) 1-year weekly chart, since their IPO