Facebook in your mutual fund? Potential risks and rewards

(CBS/AP) BOSTON — Ask people what they think about Facebook, and you're likely to hear everything from "It's a terrific way to connect with friends and family," to "It's a colossal drain on time and productivity."

Soon, you could start getting a third response: It's a big investment opportunity.

Facebook stock is expected to begin trading publicly on May 18. Market pros and average investors alike are sizing up the company's strengths and weaknesses. The key question: Can Facebook parlay its vast legions of users into huge profits, as Google did following its 2004 initial public offering?

The Facebook IPO is expected to be the biggest for an Internet company, surpassing Google's. It will be hard for mutual fund managers to ignore; especially those specializing in technology stocks, and the large-cap, growth-stock market segment that Facebook will join.

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Facebook might seem to be an obvious potential buy for those managers, given its amazing rise from Harvard dorm-room startup in 2004 to the world's largest online social network.

But successful stock-picking means being price-conscious. Until late last week, fund managers had little to go on in assessing Facebook's potential investment value.

That's when Facebook disclosed that its shares would be priced in a range of $28 to $35. The specific price is to be released the day before trading, and decision time is approaching for fund managers considering Facebook for their portfolios.

A select few have already jumped in. Dozens have acquired private shares of Facebook over the past year-and-a-half.

More than 30 Fidelity Investments mutual funds recently owned private Facebook shares, including Fidelity's largest stock fund, Contrafund (FCNTX). But Facebook made up just 0.1 percent of that $84 billion fund's portfolio at the end of March, and other Fidelity funds holding Facebook had similarly small investments.

Another big fund company, T. Rowe Price, recently reported that 19 of its funds owned private Facebook shares, in nearly all instances making up less than 1 percent of each portfolio.

Morgan Stanley has also been active. Its $1.7 billion Focus Growth Fund (AMOAX) recently held 3.6 percent of its portfolio in Facebook shares.

Funds from smaller companies have purchased Facebook stock on secondary markets that are off-limits to average investors. Below are comments from interviews this week with managers of two such funds: Chris Brown of Pax World Balanced (PAXWX) and Thomas Vandeventer of Tocqueville Opportunity (TOPPX). They discuss prospects for the stock:

Rewards

Facebook's potential is undeniable because the site has more than 900 million users. There are huge profit opportunities for Facebook and its investors from advertising revenue.

Brown believes much of that is still untapped. He sees a big opportunity if Facebook can generate earnings from highly-targeted ads tailored to appeal to specific Facebook users based on their interests.

"Right now, the ads are more about building brand awareness," Brown says. "But if advertisers could specifically target a certain demographic, by age group or gender, for example, that's where the profit margins would be very beneficial."

Vandeventer is cautious about the short-term outlook, but optimistic in the long-run.

It's still a pretty young company, and we don't really know how it will find a way to significantly increase the income it generates from online services, he says.

But he adds that Facebook has attracted half of all current Internet users on Earth, "so it's a huge opportunity for a profitable business model."

"It is not that different than if you had invested in Google back in 2004, or even LinkedIn a year ago," he says. In both cases, the companies went public as their income-generating potential was still unclear. Yet each has proved itself. Google's shares debuted around at $100 apiece, and today trade at around $615. LinkedIn shares opened at $45 last May, and now trade at around $112.

Risks

Despite its vast user base, Facebook isn't yet generating a huge amount of revenue by Wall Street standards. Although first-quarter revenue grew 45 percent from a year earlier to $1.06 billion, it declined 6 percent from the fourth quarter.

"They may have to spend more money to grow this business, and that could put pressure on profit margins," Brown says.

Other key challenges include attracting more users who access Facebook from mobile devices such as smartphones and tablets, and generating mobile ad revenue. Most Facebook users are on personal computers, and Brown believes Facebook is lagging somewhat in the faster-growing mobile space.

Mobile applications could be a good growth driver, but could also be a challenge for them, Brown says.

Another key issue is whether Facebook can someday expand into China. It's shut out now. China's government blocked Facebook as well as Twitter after the social media services were instrumental in anti-government protests in Iran two years ago.

However, Vandeventer still sees plenty of opportunity to grow globally.

Facebook has penetrated only 60 percent of the U.S. market, he says. "Then there's India, Brazil and so on. There is still plenty of potential growth."

Big picture

Facebook has established its user base, and increasingly its prospects depend on execution. Vandeventer believes Facebook's executives are capable of building a hugely profitable business, although founder Mark Zuckerberg isn't a typical CEO. This week, the 27-year-old showed up at meetings with prospective investors wearing a hoodie, a staple of his wardrobe.

Vandeventer attended a New York City meeting, and he's comfortable with the executive team's youthful vibe.

"Who cares what Mark Zuckerberg wears to his meetings? I don't," he says. "What I care about is that he executes. The team that I saw has a pretty firm grasp of what's going on."