Facebook IPO: A Rookie Investor Trap

NEW YORK ( TheStreet -- Facebook is reportedly looking to raise $10 billion in an IPO that could arrive as soon as April 2012, but retail investors should be wary of wading in the first chance they get.

There's an emotional draw that can sometimes make people more comfortable buying companies that they are familiar with, but folks sucked into buying Facebook during what's sure to be dramatic first day of trading may want to take a look at the downward trajectory that's followed the bombastic debuts of other buzzy Internet names like LinkedIn ( LNKD) and Groupon ( GRPN).

Chris Nagy, a managing director overseeing order execution at TD Ameritrade ( AMTD), says retail customers often end up paying huge premiums since they have to wait until the stock hits the open market.

"They know the name and get caught up in the first day frenzy," Nagy says. "The problem is that the more high profile names are more attractive to long term investors, people that trade less than 10x a year."

"If you look at the pure statistics, if that investor would have waited 30 days they would have been better off," said Nagy. "Our average buy order on Groupon was traded at $28 on that day and now it's at $15."

Nagy also pointed out that FINRA, the Finanical Industry Regulatory Authority, has instituted a rule that prevents market orders on IPOs that just went into effect in order to protect investors from that first day run-up. So, TD Ameritrade will now ask customers to place a limit order for first-day IPO trades.

The 800 million users of Facebook have turned the Web site into an Internet phenomenon but does that mean the company is worth $100 billion?

Francis Gaskins, President of the IPO Desktop, notes for comparison that Google's IPO valuation was $23 billion and the company is now worth $190 billion. Private market exchange operator SharesPost currently values Facebook at $73 billion.

But insiders will be inclined to sell as soon as they can so it will be up to buyers in the after-market to drive up the price.

A review of recent internet IPO performance should serve as a warning. Groupon launched to huge buzz, but has dropped well below its $20 per share pricing with much of that decline coming in the past few weeks. A number of other recent Internet IPOs have encountered similar turbulence, including Angie's List ( ANGI), HomeAway ( AWAY), and Zillow ( Z).

Neil Dhar, partner, transaction services at PriceWaterhouse Cooper, says investors need to realize it takes more than familiarity to justify purchasing stock in a company.

"Some do quite well initially due to branding because people fell it and touch it on a daily basis," Dhar says. "But an IPO has multiple facets - historical performance, future growth and the ability to market the company are all the ingredients of a successful IPO."

Facebook fans argue though that the company has more going for it than just name recognition and be able to support a lofty valuation for the IPO and beyond. The company could also take the money it raises and embark on an ambitious M&A strategy.

Getting an accurate read on Facebook's financials is still difficult as the company has yet to file its S-1 registration statement with the Securities and Exchange Commission. The social networking giant is seen generating revenue of $4.27 billion this year, according to Bloomberg, which cited information from research firm EMarketer. Some $3.8 billion that revenue is seen coming from advertising, according to EMarketer, a 104% hike from 2010.

IPO Desktop's Gaskins is a skeptic though. He believes Facebook shares will make a splashy debut but could slump when the actual revenues and earnings are made public.

If that happens, newbie investors could end up joining a Facebook losers group to commiserate about why the company wasn't able to back up the hype.

-- Written by Debra Borchardt in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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