Facebook finally floated and promptly dropped 18% from its $38 IPO price. So hyped was the new issue that, priced at the top of its valuation range, there was insufficient demand to support the stock once trading commenced.

But the short-term gyrations of the share price are only of interest to traders. Longer-term holders of Facebook stock will receive a positive return on their investment if and when the company succeeds in monetising its 900m global user base.

The company is creating new business models to capture revenues from its free-to-use service. The debate on valuation is about how quickly and successfully it can accomplish this.

Hype

That truly massive captive customer base is the reason behind the hype.

Even the Financial Times' authoritative Lex column had an online Facebook IPO calculator. Apparently, if revenue growth tails off gradually from 2011's 88% to a modest 10% by 2018, EBITDA margin remains steady at 50%, capex to sales drops steadily from 30% to 5% over the period and the terminal growth rate from 2019 is 3% pa then, with a few assumptions about risk free rate and equity risk premium thrown in, Facebook's shares are worth $43.

To be fair to the FT, its purpose was to illustrate what heroic assumptions are required to get to a $100bn-plus valuation. But that very methodology of plugging growth assumptions into a DCF model highlights the widespread mis-pricing of the business risk.

If Facebook takes a bath, it will be down to the kind of disruptive change that it has itself created. It's in the nature of such change that it's not readily predictable, but there are plenty of precedents that demonstrate the fickleness of consumer tastes in the social network and technological spaces.

Fickleness versus stickiness

The closest precedent is, of course, Rupert Murdoch's ill-fated acquisition of MySpace. A $580m investment was sold for $35m six years later, as the social network lost out to the then-smaller Facebook. Before that, ITV (Other OTC: ITVPF.PK - news) lost 150m of its 175m investment in Friends Reunited.

Here is the original post:

Why I Wouldn't Touch Facebook With A Barge Pole