Facebook IPO: Four More Reasons (and Counting) to Avoid It !

By Louis Basenese, Chief Investment Strategist

http://clicks.wallstreetdaily.com//t/AQ/AAp7bQ/AAqN+Q/AAQQ7Q/AQ/A0xlZg/1yiZ

Pop quiz time. Do these fundamentals smack of a good investment opportunity?

~ Slowing growth
~ Higher expenses
~ Fewer profits
~ And stagnant selling prices

And the answer? Not just no, but hell no!

Yet those are the latest fundamentals for Facebook, which were revealed in a revised S-1 filing on Monday.

Of course, the underwriters would like us to ignore them and buy into all the social media hype and, in turn, Facebook's stock.

But let me say it again so it's Colonel Jessup-style "crystal clear." We should avoid the Facebook IPO like the plague.

Here are the latest reasons why...

The "Outdated" Science of Fundamental Analysis

You'll recall that during the dot-com bubble, Wall Street asked us to throw out "outdated" fundamental analysis metrics like earnings and sales growth and return-on-equity.

In their place, we were supposed to value a stock based on things like page views, clicks and unique visitors.

To paraphrase Dr. Phil - because he gets no love in the financial press - how'd that work out for us? Not so well.

At the end of the day, profits are what ultimately matter. Case in point: When dot-com companies failed to produce them, they tanked.

And yet here we are, a little more than a decade later and Wall Street's trying to get us to abandon fundamental analysis once again. Don't fall for its dot-com era magic tricks of distraction.

As I told you before, the $100 billion valuation being bandied about for Facebook's IPO isn't supported by real-world examples.

Companies with comparable market caps - like Cisco Systems (Nasdaq: CSCO) - are producing more in profits than Facebook is in annual sales.

Instead of paying attention to Facebook's meager profits, though, we're supposed to focus on Facebook's meteoric increase in users. And then believe one day it will leverage that user base to generate enough profits to justify its lofty valuation.

For argument's sake, let's go ahead and believe in the potential of its user base. When we do, a problem quickly arises.

Facebook's user growth is slowing. Dramatically. It's down from solid double digits to close to 6%. Across all geographies. Take a look:

In an earlier article, I guaranteed that this slower growth would happen. And it is happening. As Lou Kerner, Founder of the Social Internet Fund, says, "We are seeing slowing growth [at Facebook], which is never a positive thing."

No it's not, Lou. Slowing growth kills stock prices. Just ask Netflix (Nasdaq: NFLX). It reported results yesterday. As The Wall Street Journal's headline reads, "Netflix's Growth Disappoints." I'll say. Shares got hammered 12% lower.

Making matters worse, Facebook's slowdown can't be dismissed as a short-term problem. It's going to persist.

Why? Because at 901 million users, Facebook is bumping up against the law of large numbers, just like Apple. So unless it adds every man, woman, child, plant and rock to its user base, it will never experience double-digit user growth again.

At the same time, it's confronting an improving jobs picture. Yes, unemployment and Facebook are linked.

I'd also posit that Facebook's novelty is wearing off. Or more simply, "Facebook fatigue" is setting in. Users aren't as engaged. Which is symptomatic of all social media companies to date. The company's $1 billion acquisition of Instagram proves it, too.

In its recent S-1 filing, Facebook confesses: "In April 2012, we entered into an agreement to acquire Instagram... to enable users to increase their levels of mobile engagement."

Reading between the lines, Facebook must really be desperate. How else do you explain paying the highest price in history for a photo-sharing startup, with only 30 million users and no revenue?

In the end, if you want to believe in the Facebook IPO based on metrics like user growth and engagement, be my guest.

I'll save belief for my religion, thank you very much. As for my investments, I'll stick to fundamental analysis.

With that in mind, let's get back to that "outdated" science and see how Facebook's IPO stacks up. (Hint: It doesn't!)

Would You Pay a Premium for THIS Stock?

In the last quarter, Facebook reported a quarter-over-quarter drop in revenue of 6.5%.

At first blush that might not sound too bad. Especially when you consider that year-over-year sales were up 44.7%. But remember, Facebook added another 56 million users in the last quarter.

It should be increasing sales as it increases the number of users. But it's not.

The company tried to blame the revenue dip on "seasonal trends." Really? Young, innovative startups are supposed to be immune to seasonal trends!

Even if we give Facebook the benefit of the doubt on the sales figures, other troubling fundamentals remain.

Take total expenses, for example. They increased 16.1% in the last quarter and 97.4% over the last year.

A rise in expenses isn't always a bad thing. That is, as long as it's accompanied by a similar rise in sales and profits. No such luck here.

Expenses rose much faster (+97.4%) than sales (+44.7%) over the last year. As for net income, it headed in the opposite direction, down 32.1% quarter-over-quarter and down 12% year-over-year.

Sorry folks, fewer profits don't add up to higher stock prices.

Most troubling of all, though, is the fact that advertising rates were stagnant. As Facebook revealed in the filing, "Average price per ad for the first quarter of 2012 compared to the first quarter of 2011 was unchanged."

Rob Griffin, Executive Vice President of ad agency, Havas Digital, says static ad prices are a "short-term problem."

I wouldn't be so quick to dismiss it, however.

As I noted last week, Facebook's nothing more than a portal to serve up advertising. (It currently derives 82% of revenue from advertising.) This early in its life cycle - and given the economic recovery - Facebook should be earning higher advertising rates, as it demonstrates its value to advertisers.

In February I provided anecdotal evidence that wasn't happening. Forrester analyst, Nate Elliott, said, "We're hearing from our clients that their return on investment from Facebook ads doesn't look anything nearly like what it does for TV, print and radio ads, or from Google advertising." Now we have the empirical evidence.

Bottom line: Much like Blackstone Group's (NYSE: BX) IPO signaled the peak of the private equity bubble, Facebook's IPO promises to usher in the peak of the social media bubble. Don't be caught on the wrong side. Based on metrics that actually matter, Facebook's IPO fails to stack up as a sound investment. So I still recommend you avoid it like the plague.

Ahead of the tape,

Louis Basenese