Facebook: Overhyped, Overpriced, and You May Own It
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The Fiscal Times
May 18, 2012

Everybody is ogling the fortunes being made from the investors and owners cashing out at Facebook -- Mark Zuckerberg: $1.1 billion, Goldman Sachs taking out nearly the same, and Peter Thiel of PayPal, collecting nearly $600 million.

Their good fortune raises an obvious question. Who’s buying? Who is plunking down the estimated $6.5 billion for the 180 million public shares that hit the market today? (The rest of the 421 million publicly registered shares will be conversions from the private stock held by insiders, venture capital firms and institutional investors – the private parties who owned Facebook before the initial public offering.)

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If you are looking to join huddled masses yearning to enrich the real friends of Facebook, there’s no need to make a frenzied call to your broker. You probably already own shares. And whether you want to or not, you are about to own a lot more.

Despite all the hype about retail investors clamoring to climb on the Facebook bandwagon (which no shortages of analysts think will never generate sufficient earnings to justify its $34 to $38 initial purchase price), the vast majority of new Facebook stock will be purchased by institutional investors. These are the folks that manage the pension plans and mutual funds that hold the tax-exempt money average Americans take out of their paychecks each month for retirement savings.

Institutional investors own over half of all U.S. equities and approximately 70 percent of all large-cap stocks, whose ranks Facebook will join tomorrow. They are the primary clients of the lead investments bank in the deal – Morgan Stanley, Goldman Sachs and JPMorgan Chase – and will have first dibs on their share allocations.

Many fund managers will buy Facebook shares because they manage index funds, exchange-traded funds that track technology stocks and large-cap technology funds. They need the shares to remain properly weighted within the sector.

Mutual funds that specialize in “growth” will also seek out a Facebook play, fearing they will miss out on the next Google (conveniently forgetting it could also turn into the next Groupon, which sold at mid-day Thursday at $12.45 a share, down from its IPO price of $20 last November).

Of course, a lot of mutual funds have already made a ton of money off Facebook. Many purchased shares from insiders in the private placement market that preceded Friday’s public offering. More than 30 Fidelity mutual funds currently own stock in the company. And while it is just 0.1 percent of Fidelity’s $84 billion portfolio, that is still $84 million spread among its investors.

T. Rowe Price has confirmed that 19 of its funds own private Facebook shares. A single Morgan Stanley fund, its $1.7 billion Focus Growth fund (AMOAX), holds 3.6 percent of its portfolio in private Facebook shares, according to the Associated Press.

Will those big mutual funds begin dumping shares like Zuckerberg, Goldman Sachs and Thiel once all its shares, both the newly minted ones and those held by insiders, are eligible for sale on the secondary stock market? They must wait 90 days before selling, two months less than the 151 days required of insiders.

They’re not talking, of course, and individual mutual fund investors can’t learn what the managers of the funds they own are doing until quarterly statements come out. That can be as long as four or five months after the actual trades take place.

But there are preliminary indications that once the initial frenzy wears off, interest in the secondary market may not be very strong. The shares will initially sell at nearly 100 times present earnings and 50 times next year’s projected earnings. The historic average for stocks is around 15 to 20 times earnings.

A survey conducted in early April by Investment News, a trade newsletter for financial advisers, found that 76 percent of investment professionals will not be recommending the stock to their retail clients. Yet more than half of those same advisers thought Facebook would outperform Google, which has gained more than 600 percent since its IPO in 2004.

It’s worth noting that most mutual funds and investment advisers perform on average slightly worse than a simple investment in an S&P 500 index fund. That index, should you choose to buy it, will soon include Facebook and funds that track the index will be among those purchasing the company’s shares tomorrow and in the months ahead.

spent 25 years as a foreign correspondent, economics writer and investigative business reporter for the Chicago Tribune and other publications. He is the author of the 2004 book, The $800 Million Pill: The Truth Behind the Cost of New Drugs.