Facebook & Goldman Sachs: Don't Be Fooled by a Facebook IPO

If you missed Google, should you bet on Facebook? We don't think so.

Facebook will IPO. And it will IPO soon. The company may have no choice if the SEC gets a hold of its records. But that doesn't mean it will be a good stock to buy.

Facebook is the most visited Web site in the world. Its founder just had a successful movie made from his life. And rumors about the company's IPO potential have investors and their financial advisors drooling.

Yes, Facebook is popular. But none of those things means the company can make any money. And Goldman's nearly half-a-billion dollar investment in the social network isn't the endorsement it seems.

Let me show you the truth behind Facebook's closed doors and the best ways to profit from the company both before and after it IPOs.

Facebook Value

Facebook just raised $500 million from Goldman Sachs Group Inc. (NYSE: GS) and Russian investment firm Digital Sky Technologies. This implies that the social media darling is valued at a staggering $50 billion.

This reminds me of the valuations being assigned to Internet companies leading up to the "dot.bomb" crash in 2000. There's no way a company that relies on nothing more than bits of information - the vast majority of which are summarily ignored by the community that supposedly finds it so compelling - should have a valuation approaching The Walt Disney Co. (NYSE: DIS), equal to The Boeing Co. (NYSE: BA), and greater than Time Warner Inc. (NYSE: TWX).

The $50 billion appraisal highlights Facebook's popularity, not its earnings potential. Facebook may have jumped ahead of Google as the most visited Web site in 2010. But it's not worth $50 billion.

We don't know exactly what the Russians or Goldman Sachs are getting for their $500 million investments. Facebook is still a private company. Nothing it does is reportable.And at this point we have no idea how much money the company is making or where it's going.

One out of every 12 people in the world visits the popular social networking site and the collection of human data that's stored there makes Facebook the largest, self-fueled marketing database in human history.

That point is well taken.

But exactly what is Facebook going to do with all of that data? The presumption appears to be that Internet advertising is the "golden egg." Unfortunately, that theory's been dead - or at least passé - for years.

Analysts estimate that Facebook could bring in as much as $2 billion in annual revenue. I beg to differ.

Even if there were products for sale, as opposed to simply being advertised, on Facebook, the backlash that's building about sharing sensitive information online could kill the company overnight - $50 billion or not. Then there's the fact that people are losing interest in the two-way drivel that at the end of the day becomes nothing more than another e-mail platform cloaked under the guise of "social media."

In its first year public (2004), Google made $3.26 billion in revenue. But Google had valid, often user-driven sales opportunities. Google's advertising targets, through its search engine, at least, are often looking to be "sold" when they go to the site. Whereas, Facebook users don't want their chatting/gaming/posting time consumed by invasive or even passive salesmanship.

Sure, Facebook has a lot of people trolling through its site, but the important question is how do they monetize that traffic? In other words, they face the same old dilemma salesmen have faced since the beginning of time: How do you convert the "tire-kickers" into buyers.

Goldman's Special Vehicle

More interesting than Facebook's supposed worth is Goldman Sach's involvement in the deal.

Goldman is investing $450 million into Facebook, with the Russian firm Digital Sky putting up the other $50 million. They both plan to package and resell their investments to investors. That makes Goldman a principal in the deal, which means in very plain terms that it can no longer claim any obligation to the investor (its customer) who buys into Facebook privately on the other side. It's important to keep that in mind.

With its Facebook investment, Goldman wants to create another of its "special investment vehicles" - one that would allow a select few additional investors to put as much as $1.5 billion into Facebook. That would mean more fees for Goldman, while also ensuring that it keeps its "investors" outside of the Security and Exchange Commission's (SEC) public disclosure rules.

Sound familiar?

It should, given that special investment vehicles and limited disclosure played a key role in creating the financial crisis that's still not over and from which Main Street is still reeling. Never mind the irony that - thanks to a taxpayer funded bailout - Wall Street bonuses are bigger than ever and that it's already back to business as usual.

According to the one page investment profile Goldman sent to its wealthiest clients, "GS Group may at any time further reduce its exposure to its investment in Facebook without notice to the fund or investors in the fund."

If that's not a conflict of interest, I don't know what is.

This clause allows Goldman to hedge or trade against the very same clients it's now putting into the deal. That, in turn, means the firm can exit or burn the house down without warning!

Of course, I love the small print, which also states that the content of the offering "is not guaranteed as to accuracy or completeness." Maybe that's why there's another line near the very bottom that advises potential clients: "Do not contact Facebook."

Could you imagine investing your hard earned money into a prospective stock offering and agreeing not to talk to the issuer to do due diligence? What ever happened to the Prudent Man Test - or at the very least common sense?

IPO, Yes or No?

By helping raise $500 million, Goldman is doing more than simply pocketing huge fees. The investment firm is positioning itself for the initial public offering (IPO) of Facebook.

Chief Executive Officer Mark Zuckerberg's has denied a 2011 IPO. But Facebook is becoming popular in private markets, like the one effectively created by Goldman's "special investment vehicle" and other private traders like the Web site SecondMarket, where former employees can sell their shares in private companies to outside investors. And this popularity could increase pressure on the company to go public sooner rather than later. Similar private interest pushed Microsoft Corp. (Nasdaq: MSFT) and Google into IPOs.

It would not surprise me in the least to learn that Goldman Sachs has a contractual right to be the manager of Facebook's IPO. If that proves to be the case, it would mean Goldman has effectively fronted Facebook $450 million for the privilege of orchestrating the company's forthcoming IPO - and then gotten its money back by selling its stake in the company off to high-end clients looking to get a piece of the social media giant.

All is not lost, though.

Several sources are now reporting that Facebook may already be over the 499-investor limit threshold that requires public disclosure.

The SEC has sent information requests to participants in privately held Internet companies, especially those that may be edging the limit to the under-500 rule. This inquiry could push Facebook to go public sooner than Zuckerberg has led everyone to believe.

The SEC is likely to find there are far greater than 500 investors in Facebook. And if so, the company would be forced to publicly disclose its financials. Although an IPO doesn't have to follow from this revelation, it is a logical step.

If that doesn't happen, the greater requirements and attention that come with being publicly traded may deter Zuckerberg from rushing his IPO plan. That, combined with the obvious, the fact that Facebook is definitely not in need of capital to grow - a common reason for an IPO, would make 2012 the earliest estimate for Facebook to go public.

My guess is that, whether the SEC jumps into the fray or not, Goldman will find a way to steer clear of the entire shooting match at all costs to avoid disclosing its own business practices - the same way it paid a $550 million fine last year to settle charges of securities fraud related to mortgage investments.

For the moment, Facebook remains a private company and does not have to discuss anything it does - such as the costs it incurs, the mounting complaints regarding personal data, or where it spends its money. Nor does Goldman have to disclose how it's profiting from the deal or acknowledge related trading positions it's establishing in the process.

Actions to Take
In the short term, don't be fooled by the Goldman Sachs name or the rumored billions in Facebook. As an investment firm, Goldman should never ask its clients to put their money in a company that doesn't disclose its earnings, expenses or future projections for both. And as an investor, you shouldn't consider putting your money into such a company, even if your financial advisor says it's "a really great opportunity" and you'll be "getting in on the ground floor". This is not the ground floor. It's the sub-basement.

When something does go wrong, GS will be more than happy to leave its investors holding the bag while it sneaks out the back, again.

If you really must buy into Facebook before it goes public, look at private trading sites like SecondMarket and find the deal that protects you, the buyer, as opposed to only protecting the seller.

In the long term, remember that Facebook may be the next AOL, not the next Google. The company is already playing catch up when it comes to Internet business models. And like AOL did a decade ago, Facebook could end up watching its customers grow too savvy to sell to.

When, not if, Facebook goes public, you can play it two ways. You could ride the frenzy and profit strictly on the popularity of the stock, not the worth of the company. This takes steady nerves and an on-call (or online) broker.

Or you could take your time, wait for the initial thrill to drain off, and do a thorough investigation of the company, its past performance and its earnings potential. If you decide Facebook has good potential to consistently make money in the future, then buy into the stock as a value investment.

[Editor's Note: Don't be fooled... The semiconductor business is booming again. Chip sales jumped 34% in 2010... and hit $26 billion in November alone. But this industry is no longer dominated by Texas Instruments and Intel. Not anymore. This Taiwanese company is suddenly selling its state-of-the-art circuitry throughout North America, Asia and Europe now. And we're banking on a short-term 88% gain here - easy. See our 2011 Investor's Forecast for details.]

About the Author

Keith is a seasoned market analyst and professional trader with more than 37 years of global experience. He is one of very few experts to correctly see both the dot.bomb crisis and the ongoing financial crisis coming ahead of time - and one of even fewer to help millions of investors around the world successfully navigate them both. Forbes hailed him as a "Market Visionary." He is a regular on FOX Business News and Yahoo! Finance, and his observations have been featured in Bloomberg, The Wall Street Journal, WIRED, and MarketWatch. Keith previously led The Money Map Report, Money Map's flagship newsletter, as Chief Investment Strategist, from 20007 to 2020. Keith holds a BS in management and finance from Skidmore College and an MS in international finance (with a focus on Japanese business science) from Chaminade University. He regularly travels the world in search of investment opportunities others don't yet see or understand.

Read full bio