Why I’ve Finally Bought Facebook: Investor

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A sign with the 'like' symbol stands in front of the Facebook headquarters in Menlo Park, California.

I did something Wednesday that I didn’t think I was ever going to be able to do. Not only did I establish a position in social media giant Facebook, but I did so while feeling good about the decision.

As a value investor, trying to convince myself that the company was worth the investment came as quite a challenge. I'm not entirely convinced of the overall value of social media. Be that as it may, I do understand that on Wall Street everybody takes a beating once in a while, and this time it was Facebook’s turn.

I have also come to understand that Wall Street can sometimes have a very short memory; not only does a beating stop, but everyone starts using the word “cheap” as a way to rationalize what has really become a change in sentiment.

The question is: Has Facebook become cheap, and did it in fact reach its bottom? Although it is hard to say with any degree of certainty absent more historical trading data, I have reason to suspect it has, since $25 has been my fair market value since its initial public offering .

If $25.52 was its bottom, where is it heading next? According to Mark Harding of JMP Securities, the next target will be $37 — or $1 short of its IPO price — while initiating coverage of the company with a “market outperform” rating. He said the “valuation appears high, but Facebook has plenty of opportunities to monetize its vast user base.” That’s not entirely a revelation; the company’s IPO valuation was heavily predicated on that assumption. But can it execute? And if so, how?

With Harding thinking the company has 42 percent upside from current levels, I have started to compare Facebook’s bottom with that of its closest peers upon their IPOs. These include Pandora Media, LinkedIn, Zynga, and Groupon. What I have found were pretty consistent patterns, some suggesting Facebook is going to be just fine in the long term.

One such example was Pandora, which opened for trading June 15. The stock started off at $20, reached the company’s high at $26 and finally ended its first session at $17.35. Today the stock is trading just under $11, as investors start to apply more conventional valuation methods to its business model.

The good thing for Pandora is that it is growing its revenue and has even earned a profit, when many were quick to proclaim it couldn’t. Like Facebook, Pandora is in a business heavily predicated on growing advertising revenue. To its credit, it has been able to do that despite increased levels of competition. Interestingly, Pandora is one of a couple of companies I think would help Facebook grow via an acquisition if it were to truly approach that $37 valuation. The more I think about it, though, the more realistic $37 now seems, as it may possibly follow the path IPO path of LinkedIn.

For LinkedIn, its first day of trading sent the stock to $45. It shot quickly up to $122.70 and closed the day at $94.25. Today, after less than a year as a public company, the stock trades at $93 in the face of severe economic uncertainty. What this means is that social media for the job market has value — particularly during employment-challenged environments. Today the company is doing all of the right things and affirming to Wall Street that it deserves its valuation. Although it is still a tad early to proclaim success, LinkedIn’s earnings report continues to show that the business has more obvious staying power than many initially believed.

Although there are some sprinkled signs of the value of social media, nothing beats having a tangible product, and I think Facebook understands this. For this reason, it has begun talks of making its own phone to secure its position in the mobile advertising market. There is one small problem with that: The company forgets that it knows nothing about hardware. For that reason, I think that it should make a play for Research In Motion or possibly Nokia.

As I’ve said recently, not only will RIM offer Facebook a better enterprise presence; Facebook will acquire assets such as RIM’s BB10 software, a growing music service as well as RIM’s Mobile Fusion, a product that supports the collaboration of enterprise mobile devices, even that of competing models such as Apple’s iPhone and Google’s Android devices. In essence, Facebook immediately becomes a hardware and services company, while also instantly having multiple routes to monetize its 900 million user base.

Bottom Line

I’ve always said that if you are not in a state of perpetual worry in the stock market, you are not paying attention. Facebook had me nervous from the beginning. The fact of the matter is, it was just too good to be true and affirmed what Warren Buffett has long warned: Investors should be fearful when others are greedy. My risk in buying at this level has more to do with the hysteria that dominated the IPO being over and more rational thinking starting to factor into the valuation.

Since $25 had been my target all along, this was an opportunity I just could not pass up. Interestingly, these were likely the same words many investors were quick to utter at the company’s IPO price of $38.

I could be wrong, and the stock can very well drop another couple of dollars from this level. At this point, I doubt it.

—By Richard Saintvilus, Contributor, TheStreet.com

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Disclosures:

TheStreet’s editorial policy prohibits staff editors, reporters, and analysts from holding positions in any individual stocks. Richard Saintvilus owns Facebook shares.

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