Avoiding the Facebook feeding frenzy

Try as they might, many retail investors won't be able to get shares of Facebook in its first hours of trading.

They may be better off waiting it out anyway. Buying at the closing price of the initial public offering day and holding on to your shares has not been a profitable strategy lately, especially for companies in the media business.

While Facebook is a unique company with 900 million users, some recent IPOs serve as reminders that the sizzle for once hot companies can fade quickly. Of seven media or social media company IPOs in the last year, only LinkedIn is now trading above where its stock closed after its trading debut.

Millennial Media, a mobile advertising company, saw its shares jump 92 per cent the day its shares debuted in late March. Since then, the stock has slid nearly 46 per cent to $US13.40, as of Tuesday's close.

Last year, shares of Demand Media jumped 33 per cent on the company's initial day of trading. Over the next six months, they fell 49 per cent, and are down about 63 per cent overall as of Tuesday. And investors who bought shares of Groupon after they closed 31 per cent higher on the first day in November have lost 53 per cent as of Tuesday's close as the company's shares slid to $US12.17 each.

Optimistic potential investors in Facebook, co-founded by Mark Zuckerberg in 2004, may consider the company immune to a post-IPO letdown because of its popularity. But there are ways investors can time their purchases to prevent getting caught up in the early euphoria.

Facebook, which is expected to have its initial public offering on Friday, is planning to raise as much as $US16 billion by selling about 421 million shares at a target price range of $US34 to $US38 each. While the company has set aside some shares for retail investors, brokers tend to reserve this allotment for wealthier clients.

Those who don't qualify will be stuck trying to get in on the buying frenzy of the first day, at a time when some analysts expect shares of Facebook to pop more than 30 per cent to more than $50 each.

Waiting a week or two from the first day of trading may prove to be more profitable than trying to get in on the first day, analysts said.

"You want some of the frothiness from the excitement of the IPO to burn off," said Jim Krapfel, an analyst at Morningstar who covers the company and values the company at $US32 per share. Buying at the first day's closing price would leave "limited upside for long-term fundamental investors," he said in a recent report on the company.

Dave Abate, a financial planner with Strategic Wealth Partners in Seven Hills, Ohio, said that he is telling clients to wait a couple of days for the stock to reach an equilibrium. Facebook is the first time his firm has developed a client strategy specifically for an IPO, he said.

"Everyone and their grandma uses Facebook and wants a piece of it. They feel like they've missed the boat with Apple and this is their opportunity to get in on the ground floor," he said.

Zuckerberg, who turned 28 this week, is one of the world's youngest billionaires, but despite the allure of Facebook, investing in the company comes with risks, such as the company's reputation with being unconcerned about user's privacy, Abate said.

"I consider Zuckerberg a pretty big risk himself. He's unpredictable and if he grows bored with the company (and leaves) I don't know what's left of Facebook at that point," he said.

Abate is also concerned that Zuckerberg has too much power, with more than 50 per cent of voting rights, increasing the risk in investing in the company. For clients that remain interested in Facebook, Abate is counseling them that there will be several dips in the future to buy the stock without buying at an over inflated value because of "short-term flippers."

One way to avoid short-term remorse: buying shares of mutual funds that already own shares of Facebook. T. Rowe Price, for instance, purchased shares of Facebook traded on private markets and has spread them across 19 funds.

Krapfel said a date potential investors should watch for is 91 days after the IPO, or August 20. That's the day that the first so-called lock-up period for 172 million shares expires, allowing some insiders to sell their shares.

The end of a lock-up period typically leads to a decline in share prices, according to a 2001 paper in the Journal of Finance by Laura Casares Field and Gordon Hanka. The pair found that a company's average trading volume tends to increase by 40 percent and shares fall an average of 1.5 percent over three days after its lock-up ends.

August will be a relatively small insider selling window. Most employees and directors, except for Zuckerberg, will have to wait to sell their insider shares after 151 days, Krapfel said. The majority of the insider shares - 1.34 billion in all, which includes Zuckerberg's stake - can be sold 181 days after the IPO.

Some analysts said that heavy selling by insiders may be a warning sign for investors.

"At this stage, if anyone sold a considerable stake at the lockup stage it would be a giant yellow flag, especially given the young age of executives," said John Kozey, an equities analyst at Reuters.

The last four months of 2012 will bring two more milestones.

Nasdaq OMX Group, the company behind the exchange, changed its rules in April to allow companies to be included in its Nasdaq 100, a cap-weighted index of the largest non-financial shares in the Nasdaq Composite Index, four months after they begin trading. Once that happens, analysts expect that index funds and ETFs that track like the Nasdaq 100, such as the $US31.3 billion PowerShares QQQ ETF, will add shares of Facebook, potentially lifting the stock by a few percentage points.

And in November, Facebook will be eligible for inclusion in the Standard & Poor's 500 Index, the benchmark for most mutual funds. S&P typically requires IPOs to trade for six to 12 months before considering the companies for its indices.

The announcement of a new company to the S&P 500 index typically results in a 5.7 per cent one-day pop in the company's shares, according to a paper in Financial Management in 2006.