Guest Post: Charles Rotblut on the Facebook Mania

My friend Charles Rotblut understands investor psychology better than most.  In his role as the editor of the AAII Journal, the flagship publication of The American Association of Individual Investors (AAII), Charles has a unique perspective on what makes investors tick.  Apropos of our raging “Would You Short Facebook” debate today, I wanted to bring Charles’s voice into the mix here.

The below comes from his weekly AAII newsletter.  Enjoy!

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The latest Facebook offering shows just how willing some investors are to participate in the latest mania, even when another bubble burst not too long ago.

Goldman Sachs (GS) is offering its clients the chance to participate in a $1.5 billion offering for shares of the social networking website. News reports say the offering values the company at $50 billion. Such a valuation puts Facebook in a very elite group; only 125 companies publicly traded in the U.S. were worth $50 billion or more at start of 2011.

The valuation looks even loftier when Facebook’s income statement is considered. Though information is limited, the Wall Street Journal reported that analysts believe revenues totaled approximately $2 billion last year. If that is the case, Facebook is being valued at 25x sales. The table below shows how this compares to various other Internet companies.

Facebook is not publicly traded and the offering comes with various restrictions. In particular, new shareholders cannot sell their shares for two years. Even if they could sell, the market is limited and the valuations are imprecise.

Then there is the lack of information. Because this is not a public offering, most of the data available with a publicly traded stock is withheld. News reports say would-be investors are being given very limited information upon which to make their investment decisions. Rather, they are being asked to buy based on the hope that they will eventually be able to pass the hot potato on to someone else before being burned.

Finally, as Bloomberg News reported, the deal’s broker, Goldman Sachs, may sell its own shares without telling clients. In the investment profile sent to clients, the investment banking firm reveals that “GS Group may at any time further reduce its exposure to its investment in Facebook (through hedging arrangements, sales or otherwise), without notice to the fund or investors in the fund.”

Given these factors and the ongoing pain of the housing bubble burst, one would think that there would be a reluctance to participate in what appears to be yet another mania. Yet The Wall Street Journal reported that the offering was “inundated with demand.” Why? Greed and aggressive sales tactics.

In another example, here is what Felix Investments told prospective investors about its Pipio Associates 1 LLC fund, according to information provided to The Wall Street Journal (special thanks The New York Times’ Dealbook Blog for linking to this article):

We are closing next week on our Twitter fund (Pipio Associates). This stock is series C and it is priced at $22 per share which is an implied valuation of $4.1 billion. That is just $200 million more than the value Kleiner Perkins just put their $150 million in. Our next close after this will be $26 per share. If you do not own stock in Twitter already it is a must. If you already own Twitter you need to add to your position. There are two absolute must-have position—Facebook and Twitter! This is the first Twitter stock we or anyone else has had in the past six months and like Facebook it will continue to trade up in price rapidly!

In other words, investors are being pitched shares on the premise that prices will be higher in the future, not the actual fundamentals of the underlying company. Both the Facebook and the Twitter offerings are clear cases of buyer beware.

None of this is to say that Facebook won’t be worth more in the future, but it does show that manias continuously happen, regardless of how bad the last crash was. Investors’ best defense against a mania is to have preset rules for evaluating an investment and buy only those investments that match the criteria. Doing so might keep you out of the latest fad, but popularity often has little to due with whether a security is actually a good investment. After all, a good investment can be popular, but being popular does not make an investment good.

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Thanks Charles!

The content of this excerpt originally appeared on Mr. Rotblut’s Seeking Alpha page, please visit and follow his work here:

Facebook is the Latest Mania (Seeking Alpha)

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Would You Short Facebook?  (TRB)