Fund Makes Facebook Available to the Masses

Goldman Sachs' controversial Facebook investment offering in January was out of the reach of most investors, but at least one mutual fund has been able to grab hold of some shares of the social networking company for its shareholders. At the end of 2010, Dennis Lynch and his team of growth managers quietly added small stakes in Facebook Class B common stock to all of their large-cap-oriented funds. For a relatively reasonable initial minimum investment of $1,000, now all investors can get a small slice of Facebook via  Morgan Stanley Focus Growth  or  Morgan Stanley Capital Opportunities (CPOAX). The table at the end of this article summarizes the amount of Facebook stock that each of Lynch's funds held as of Dec. 31, 2010.

What's intriguing is that it appears Lynch was able to buy Facebook shares for his funds before Goldman Sachs' January 2011 $50 million investment that valued the company at $50 billion. Morgan Stanley and Lynch have kept tight-lipped about where they obtained their shares, only telling us that it was through a private transaction. Using The Wall Street Journal's history of Facebook valuation points, the timing of Lynch's purchase and its large size suggest that he might have acquired the funds' $59 million stake from venture capitalist Accel Partners, which sold about 15% of its stock in November 2010 for $517 million. (As a private company, Facebook and its shareholders aren't required to make any SEC filings detailing sales or purchases, even for very large transactions.) The Accel deal valued the company at $35 billion. If that's the case, Lynch's stake may have already appreciated by more than 40%, based on the January Goldman Sachs valuation.

How Morgan Stanley values those shares adds a layer of complexity to the investment. Firms that trade on public exchanges such as the New York Stock Exchange have highly visible prices and market values, which directly feed into a fund's net asset value. Because Facebook isn't traded on the public markets, Morgan Stanley has some discretion with valuing those holdings. Morgan Stanley says it is following its fair valuation pricing procedures for valuing the funds' Facebook positions, though it would not go into detail on those procedures. There are pitfalls to holding illiquid and infrequently traded stocks in a mutual fund, such as not being able to sell the shares quickly if the fund needs to raise cash to meet redemptions. My colleague, Russ Kinnel, describes other perils in this 2009 Fund Spy article.

The funds' Facebook positions aren't large, but the risks and potential rewards of owning it are considerable. While Lynch wouldn't comment on Facebook specifically, the company seems to fit one of his key investment criteria. Lynch and his team emphasize firms with sustainable competitive advantages, which Facebook may have via the site's strong network effects. That network effect, which occurs when the value of a product increases as more people use it, theoretically bolsters Facebook's value as it becomes harder for users to switch to competitors. Also, by getting in at this relatively early, pre-IPO stage, Lynch lessens the possibility that he's buying at the market top of this highly touted stock. Based on the activity on online services that let people trade shares of private companies, such as SharesPost.com, investors already assign the company a market value of nearly $70 billion. Investors who wait until the firm's actual IPO stand a greater chance of paying higher prices for the company and thus reducing their potential returns.

As for risks, Facebook accounts for a little less than 2% of the assets of Morgan Stanley Focus Growth or Morgan Stanley Capital Opportunities. While these are noteworthy stakes, they're not going to make or break the fund. So, if Facebook stumbles, the impact on the portfolio should be relatively small. Nevertheless, while Facebook may enjoy its network effects now, it still faces obsolescence risk as its competitors strive for a piece of its market. After all,  eBay (EBAY) was once considered a networking juggernaut and hot growth company, but it now faces more competition, has lagged the broad market over the past five years, and is owned by value-oriented funds like  Dodge & Cox Stock (DODGX) and  Vanguard Wellington (VWELX).

So far, Facebook hasn't shown up in the holdings of other mutual funds in Morningstar's database, but given the interest in this unusual and fascinating company, we'll be keeping a close eye.

  % Portfolio Market Value ($) Number of Shares Morgan Stanley Focus Growth 1.78 30,975,703 1,556,568 Morgan Stanley Cap Opportunities 1.68 6,310,370 317,104 Morgan Stanley Inst Capital Growth 1.79 15,095,543 758,570 UIF Capital Growth 1.83 1,725,569 86,712 Morgan Stanley VIS Cptl Opportunities 1.80 5,231,372 262,883 Total   59,338,557 2,981,837