Facebook's 33% Chance of Success

NEW YORK (TheStreet) -- I ruffled some feathers recently when I suggested that the larger-than-life event known as the highly anticipated IPO of social media giant Facebook (FB) has been embroidered in hysteria and blown entirely out of proportion. As popular as Facebook has become, the exaggerated valuation defies logic.

Indeed Facebook is a good idea with a concept that is unequivocally successful. But not only does it have no business being compared to names such as Apple ( AAPL) and Google ( GOOG), the company has yet to prove that it has a business -- at least one that is sustainable.

What Is the Value of Social Media?

Facebook said recently it earned over $1 billion during the first quarter while also reporting a 12% decline in net income from the year earlier. All of the decline was attributed to an increase in spending. While not entirely a huge concern, it does raise some red flags.

Fundamentally, how does one place a quantifiable value on social media -- a nontangible product? As a value investor, I have no answer based on fundamental analysis.

I have scoured recent IPO data from names such as Pandora Media ( P), Groupon ( GRPN) as well as LinkedIn ( LNKD) and what I've found were pretty mixed results. As with Facebook each of these stocks generated more than their share of interest from the stock market and -- just like Facebook - none had any discernible or sustainable business from which to fairly appraise value.

In assessing what to expect from Facebook as a public concern, we can look at these three names and ask, if we had to do it all over again, would we still have made the investment?

Pandora

On June 15, 2011 Pandora first went public. The stock opened at $20, reached the company's all-time high at $26 and finally ended its first public session at $17.35. Questions were raised regarding the company's ability to ever earn a profit since it had not been able to accomplish that feat the 10 years prior as a private company.

The company surprised investors in the third quarter of 2011 with its first-ever profit of $638,000. However, as the chart above shows, Pandora is finding that it is in a highly competitive landscape and trades in a market that is anything but forgiving. Since reaching $14.75 on February 6, the stock is down 41% and 66% from its 52-week high.

The reason for the punishment was simple, the company reported fiscal fourth-quarter revenue and profit per share that arrived below analysts' estimates, and forecast the current quarter's results to miss by a pretty significant margin. Revenue in the three months ended in January rose to $81.3 million, yielding a net loss of 3 cents a share while analysts had been projecting $83 million and a loss of 2 cents a share.

As excited as the market was with its IPO, investors have quickly turned away and waiting for the company to prove that it does have a business that is sustainable. Will Facebook make the same mistake?

Groupon

Groupon was another popular IPO and one that is now currently trading at its 52-week low. The company provides a way for users to purchase deeply discounted vouchers for use at local businesses such as restaurants and salons. Does that make it a good investment?

Groupon first opened for trading on Nov. 4 at $20 and reached an all-time high of $31.14 while closing respectably upon its open price at $26.11. But unlike Pandora, it did not take long for panic to set in as the stock quickly dropped to the low teens of $14.85 only a few weeks after first going public. Today the stock trades at $10.31, down 60% since reaching $25.84 on Feb. 8 and down 67% from its 52-week high.

What investors quickly realized is that not only are the company's chances of earning a profit more in doubt, but competition is exceptionally fierce among existing titans such as Google, Amazon ( AMZN) and a rejuvenated Yahoo! ( YHOO). Clearly, it would take little to no investment at all from either of these names to launch a competing product to squash Groupon's chances of survival.

As with Facebook, its business model was relatively new but investors placed more value on the idea rather than the business. So the question is, will Facebook become a similar mistake?

LinkedIn

LinkedIn allows its users to connect with other professionals whether within their industry or outside. Users are able to post their resumes, connect with past and present employers while being able to apply easily for new jobs. The Web site has versions in over a dozen different languages and over half of it users are located outside of the United States. Clearly it is a brilliant idea. However does that make it a brilliant business?

As the chart above shows, investors have not been able to make up their minds as to whether or not LinkedIn is a fundamentally sound business. However, to its credit, unlike Pandora and Groupon, the company continues to show increased levels of resiliency and more importantly survivability.

The company first went public on May 19, 2011 and opened the first day of trading at $45. The stock then quickly shot up to $122.70 and then closed at $94.25. Clearly there wasn't anything normal about its expectations and even today that sentiment would still hold true. But the company is doing its best to affirm that it deserves its valuation.

Although it is still a tad early to proclaim success, LinkedIn's earnings report showed the business has more obvious staying power than Groupon. The company reported a first-quarter profit of $5 million, or 4 cents a share, compared to net income of $2.1 million for the same period of a year ago.

Is it possible that Facebook just might indeed model the relative success of LinkedIn? If so, will it be good enough?

Moving Forward

So, back to the question, if investors could do it all over again, would they still make the investments within these three IPOs? I'm guessing two out of three might say no -- with LinkedIn still garnering votes.

For Facebook, there is no denying that it has become an incredible phenomenon, one that is proud to report almost 1 billion in active monthly users. That is almost 15% of the world's population, all interconnected with Facebook. The company provides a potential consumer base that is unmatched in the world today. From that view, its potential to offer immediate returns to businesses in the form of targeted advertising is enormous. But does that make it worth over $100 billion? That is what Wall Street thinks. But I believe investors are quick to confuse a great idea with a great business, two entirely separate terms.

Bottom Line

I am a skeptic by nature and anytime I sense that I have discovered something that is too good to be true, I tend to think that it is. That said, it does not mean that Facebook will not be a huge success. However, I think perspective is something that is often missing on Wall Street when it comes to these perceived "sure things" -- particularly in the IPO market.

While Groupon will likely soon fade away and Pandora will continue to operate until (interestingly) it gets acquired by a name such as Facebook, LinkedIn is showing that a great idea can also translate into a sound business. Based on these examples, it seems Facebook has a 33% chance of being successful.

I wonder, will investors "like" these odds?

At the time of publication, the author was long AAPL.

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