Facebook’s “less than stellar” IPO

By Xavier Forneris, May 22, 2012

Since I started my blog last December I have written several posts on the valuation of internet businesses in general and social media in particular. I noted that the valuation of these companies and the hype surrounding their IPO’s seemed, with some exceptions, excessive. To the chagrin of my friends who love their Facebook and Twitter, I mentioned my concern about the possible occurrence of a new internet “bubble”. I said that the then forthcoming Facebook IPO would be an interesting test.

Well, the IPO took place last Friday (NASDAQ:FB), as everyone knows by now, and it has been less than stellar thus far, and this is an understatement. From an offer price of $38,  Facebook’s stock opened at $42 on Friday, May 17. It hovered above $40 and then started to sink quickly. With heavy support from Morgan Stanley, the lead underwriter, the stock closed on Friday at just above the IPO price. But Morgan Stanley could not afford to support Facebook’s stock price indefinitely. In both trading days this week (Monday and Tuesday), Facebook’s stock plummeted. Tonight (05/22), it closed at about $31, down 18% from the list price. And it continued to fall in after hours trading ($30.50 at 07:59pm EDT).

And now the blame game has started to determine whose “fault” it is: Mark Zuckerberg, Facebook’s Chairman and CEO? David Ebersman, its CFO? The underwriters and their analysts? Greedy or naïve investors who equated “like” and “buy”? Not surprisingly, several theories and possible explanations have already appeared in the media. These theories are not mutually exclusive and could all have contributed to the situation.

According to Business Insider’s Henry Blodget (05/22) the analysts at the lead underwriters for the Facebook IPO may have secretly cut their estimates and this information about the estimate cut was “verbally” shared with institutional investors but not with smaller, individual investors. Once these institutional investors heard about the estimate cut they became more cautious about the IPO, possibly buying less shares than they initially intended.This form of “selective dissemination of information “ might constitute a violation of U.S securities laws and could very well prompt an investigation by the SEC and /or FINRA. Before Blodget, Alistair Barr reported on Reuters (05/22) that the research analysts at the lead underwriters—Morgan Stanley, Goldman Sachs, and JP Morgan—had cut their earnings estimates for Facebook during the company’s IPO roadshow, a highly unusual event.

Another possible explanation is that the offer price was selected for “perfection”, meaning that Mark Zuckerberg and his team would have chosen that particular price in order to attain the most symbolic objective of a $100 billion valuation. This is another way of saying that the price was “disconnected from the fundamentals”, which is seldom a good thing.

Incidentally, I reported a few weeks ago that when Facebook acquired Instagram for $1 billion, Facebook had to “show its hand” and give Instagram a price for its own stock because it was not an all cash deal. According to media reports that price was about $30 per share of Facebook…pretty close to the $31 closing price today. Maybe, the stock should have been offered at $30 instead of $38…

Finally, some are saying that too many shares were offered while others are blaming NASDAQ for its system failures on the first trading day. What ever the reason may be, I think we can all agree that this is already a public relations disaster for Facebook. It could turn even “uglier”: a Los Angeles-based law firm already filed a lawsuit against Facebook and the IPO’s underwriters; while in New York another group of investors seeking class-action status sued Nasdaq.

Now, I don’t know who’s to blame, if anyone, nor would I dare to predict what the stock price will do in the future. Over the long run, Facebook may turn out to be a great investment. With close to a billion users, Facebook has a very real and significant potential for more advertising revenues. The future will tell if the company can translate this potential into real revenues.

Sources / Read More:

“EXCLUSIVE: Here’s The Inside Story Of What Happened On The Facebook IPO”, Henry Blodget, Business Insider, May 22, 2012. Retrieved at: http://www.businessinsider.com/exclusive-heres-the-inside-story-of-what-happened-on-the-facebook-ipo-2012-5

“Insight: Morgan Stanley cut Facebook estimates just before IPO”, Alistair Barr, Reuters, May 22, 2012. Retrieved on Yahoo! News at: http://news.yahoo.com/insight-morgan-stanley-cut-facebook-estimates-just-ipo-051601330–sector.html

“4th Update: Facebook Shares Continue Selloff On 3rd Trading Day”, Drew FitzGerald, Dow Jones Newswires, retrieved on The Wall Street Journal online edition, May 22, 2012, at: http://online.wsj.com/article/BT-CO-20120522-719402.html

Facebook: an IPO in the coming weeks, a recent acquisition, and the issue of valuation

By Xavier Forneris

In my Dec. 8, 2011 post on valuation of internet businesses I talked about the possible Facebook IPO, noting that the IPO might raise $10 billion, which would value the company at about $100 billion (about half the size of Microsoft). Since then, two major developments occurred: first, Facebook confirmed its intention to go public. And second, Facebook made a major acquisition which gives us an interesting insight into Facebook’s potential value. In early April, Facebook bought Instagram, a photo-sharing service, for $1 billion . And since it was not an all-cash deal, Facebook had to give Instagram a price for its own stock, which apparently was about $30 per Facebook share. That share price would value Facebook at “only” $75 billion. However, in a very interesting piece, the New York Times  (Business section, April 19) wrote that, as part of the acquisition negotiations, the companies discussed a possible Facebook valuation of $104 billion. This is consistent, and even slightly above the analysts’ estimates which I mentioned back in December when the Facebook IPO was a growing -but yet unconfirmed- rumour on Wall Street and in Silicon Valley. This higher valuation is also consistent with what Facebook is said to have traded for on the secondary market (up to $40 a share).

The actual IPO, expected in May, will reveal whether Facebook’s valuation is closer to $75 billion or $104 billion. In a way, either value would be quite remarkable for a social network that started in 2004 and only had $3.7 billion in revenue and $1 billion in profit last year….Regardless of the exact amount, it is safe to assume that there will be more questions about the methods and multiples used to value internet businesses as well as more talks about the “next internet bubble”.

Zynga’s first trading day (Dec. 16, 2011)

Credit: Zynga (Dec. 16, 2011)

By Xavier Forneris

In a previous post, on Dec. 13, I talked about the question of valuation for social media and other internet businesses. In that post I mentioned the imminent IPO by Zynga, maker of games for Facebook such as “Farm Ville” or “Mafia Wars”. Today was Zinga’s first trading day and I wanted to provide a follow-up on this. So how did it go?

Well, on the one hand, Zynga met its objectives which was to raise $1 billion through its initial public offering. It sold 100 million shares at a price of $10 each, i.e., at the top of the $8.50 to $10 range that was expected. But, on the other hand, after an early surge to $11.50 the share price (listed on NASDAQ under the symbol ZNGA) fell and closed at $9.50, or 5 percent less than the initial price. This was also in sharp contrast with LinkedIn’s first trading day after its own IPO, closing at $122.90 from a starting price of $45 per share.

Although the IPO gives Zynga a $7 bn valuation, the drop was significant but not entirely surprising: shares in Japan-based Nexon, which also makes games for Facebook platform and went public earlier, have already registered a 15 percent drop since Nexon’s flotation. The questions thus remain “are the valuations justified; are shareholders paying too much?” Zynga’s valuation of $7 bn represents a multiple of 6.8 times in relation to its annual revenue (for the 12-month period ending Sept. 30). In comparison the market capitalization of Electronic Arts, maker of games for mobile devices, was $6.9 bn on 12/15/2011 but this only represents about 1.8 times its one-year sales. Why does one have a multiple three times that of the other, when these firms seem fairly similar? Do investors have reason to believe that Zynga’s growth potential is three times bigger than Electronic Arts’?

Another way to answer the “Are investors paying too much?” question is to look at the stock price of companies operating in the same “social space”. Interesting data on this was offered in a Bloomberg Business Week piece on Zynga’s IPO also published today. The article quotes Kevin Pleines, an analyst at Birinyi Associates who wrote in a December 13 research note:

Sixty percent of the Internet or social-media companies that completed U.S. IPOs since 2010 are trading below offer price. Buyers of the shares at their opening trade in the public market have lost an average of 32 percent.

These numbers should give investors pause. No doubt, Facebook’s IPO in the new year will be watched very closely.

Source: Zynga Declines in First Day of Trading After $1 Billion IPO, by Lee Spears and Douglas MacMillan, for Bloomberg Businessweek, Dec. 16, 2011.