Will disappointing Facebook numbers scare away investors?

The short answer is no. They will have an extremely successful IPO on launch day followed by volatility for a month. How they handle the volatility will determine how successful it will be long-term, but the first few months will be measured on “how” rather than “if it’ll be” successful.

The longer answer is a bit more disconcerting and may make the long-term prospects for a Facebook IPO look something like what is happening with Groupon (pictured above). The fourth amendment to their S-1 filing with the SEC revealed some risks that many had speculated about but nobody knew for sure until Monday. Among the concerns are plans for future acquisitions, increasing costs through headcount, and slowing of mobile growth.

One notable exclusion from the list of concerns is the drop in revenue from 2011Q4 to 2012Q1. The revenue was reported much higher than expected before and this drop is understood as a shift in advertising dollars from the holidays to now. If anything, the drop is less than expected, though some disagree.

“It was a faster slowdown than we would have guessed,” said Brian Wieser, an analyst with Pivotal Research Group. “No matter how you slice it, for a company that is perceived as growing so rapidly, to slow so much on whatever basis – sequentially or annually – it will be somewhat concerning to investors if faced with a lofty valuation.”

This is definitely true for the safer, long-term investors but the bulk of those who are considering the public offering will buy into the seasonal reasoning that Facebook is pushing forward. They are out of growth mode for a user base. It’s time to focus on innovation and revenues, which is exactly why they’re launching the IPO now.

The concerns

Let’s take a look at the three biggest concerns and what they mean to investors:

• Plans for future acquisitions – “Our ability to acquire and integrate larger or more complex companies, products, or technologies in a successful manner is unproven.” they reported in the amendment. “In the future, we may not be able to find other suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all.” This is big mistake in strategy for Facebook ahead of the IPO. The amount of money, potentially around $10 billion, begs for more acquisitions. It’s through excitement of acquisitions and launches that stocks are able to spike. This plays well for conservative investors but not for aggressive ones.
• Increasing costs through headcount – A company as young as Facebook must scale according to revenue. Google is the exception in the equation; others that have proceeded Facebook that grew too fast (Yahoo, AOL, MySpace) accumulated costs ahead of revenue and were unable to maintain them. If Facebook keeps growing at a rate faster than revenue is growing, investors will view the IPO as a way of sustaining rather than growing.
• Slowing of mobile growth – This is arguably the most concerning stat considering the rapid rise in mobile activity. Year-over-year from the end of Q1, 2011, mobile usage increased 33% compared. The rate hit 39% through 2011, meaning that despite tremendous increases in both mobile devices and time spent on them per user, Facebook mobile usage is leveling off. It should be doubling.

“The biggest issue is the realization that Facebook is not going to have an easy time meeting high expectations of the public market,” said Jeff Sica, chief investment officer of SICA Wealth Management. “It will affect how people look at the IPO.”

A lower class of investor

Money is money and IPOs one-tenth the size of Facebook’s have always shown a diverse mix of investors, but the amendment hurts the ability of Facebook to gain long-term investors. The ride will be bumpy, but this news makes it more likely that we’ll see something similar to what has happened with Groupon since their IPO.

The report will increase the number of people who get in and get out quickly. It will also increase the number of investors expecting the stocks to fall dramatically in the short term, making them wait until they feel it hits bottom before buying. These types of “lower class” investors will take an already-anticipated bumpy ride and make it even rougher for the first few months.

This will scare away the big money. It will be a concern for those who think about investments in terms of years, the types of investors that companies covet for stability.

It’s still sexy today, but this news reaffirms the idea from nearly a year ago that Facebook’s IPO may be the worst tech investment in history.