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”.

2011: The Year of the Failed IPO Comeback

By Xavier Forneris

In my January 6 post, I talked about the Internet IPO’s of 2011, indicating that most of them had been either disappointments or total flops. I gave the example of the much-anticipated Zynga IPO (in December 2011). Zynga closed its first day of trading at 5% below the offer price; by Dec. 30, it had lost almost 6%. In fairness to Zynga, I could have mentioned bigger losers:

  • Friend Finder Networks (IPO in May 2011) fared even worse: at the first day close it was 21.5% down; by year-end, it had lost a whopping 92.3%, trading at 77 cents, from an offering price of $10. 
  • Tudou, the Chinese online video company, listed on the NASDAQ in August (offering price $29) and finished the year at $10.5, a 64% decline.
  • Renren, a social networking internet platform, also from China, was listed on the NYSE in May, at an offering price of $14 and ended the year at $3.55, losing almost 75%
  • Demand Media, the Santa Monica (CA) online content publisher was offered on the NYSE at $17 in January; it closed the year 61% down, at $6.65.

The other Tech or Internet companies that had IPO’s in 2011 and closed the year on 30 Dec 2011 with a stock price lower than the offering price included Pandora Media, Zipcar, Boingo Wireless, and Yandex. To be fair, I also mentioned a few successful Internet/Tech IPO’s in 2011: LinkedIn, Jive Software, Angie’s List, Zillow, Groupon, Fusion-io and Bankrate, all closed the year at a price that was above their respective offering prices. A few of them actually had a quite impressive performance:

  • LinkedIn gained about 40% between its IPO (May 19) and Dec. 30, the last trading day of the year. This was probably the best or one of the best-performing IPO’s of the year, across all industries, in the U.S.
  • Jive Software gained 33.33% between its IPO (Dec. 12) and Dec. 30
  • Angie’s List gained 23.85% between its IPO (Nov 17) and Dec. 30
  • Zillow gained 12.4% between its IPO (July 20) and Dec. 30.

But in spite of these few successes, the fact remains that we can’t call 2011 a successful year for Internet IPO’s. In fact, I mentioned a grim finding by Birinyi Associates: 19 of the 31 Internet and Social Media companies that went public in 2011 are trading below their offering price. Acccording to Renaissance Capital, stock of Tech companies that went public in 2011 have fallen 15%.

I’m not picking on Internet businesses. I did also mention that it was not just the Tech or Social Media companies that were on that “rocky IPO boat”. As 2011 showed the signs of a prolonged global economic slowdown and a worse-than-expected European fiscal crisis, and as the public anger at Wall Street only grew stronger (evidenced by the “Occupy Wall Street” movement) companies that dared to go public in the U.S. did not fare extremely well, across sectors and industries.

Collectively, IPOs that went public this year lost 13% of their value, the first negative return since 2008, and about two-thirds of companies that went public this year are trading below their offering price (Source: IPO Boutique).I have not looked at European IPO’s yet but I suspect that they did not fare much better. Because of the adverse environment and tepid investor reaction, several companies that had lined up for IPO’s chose to postpone them and to wait for “better days”. Those include, for instance, GSE Holding, FusionStorm Global, and Luxfer Holdings. As in the Tech sector, there were a few successes. One of the most talked about was the IPO of luxury clothing and accessories company Michael Kors Holdings Ltd., which was priced higher and sold more shares than expected.

Will 2012 be a better year for IPO’s, especially in the U.S.? I wish I had a crystal ball…Much will depend on the global outlook and how Europe manages its debt crisis. But you can bet that IPO’s will be watched very closely, as a bellwether for the overall economy. And no IPO will be observed more than that of Facebook, if Mark Zuckerberg indeed decides to go ahead with the IPO, as the rumour has it, perhaps in the first half or maybe the first quarter of 2012. Other closely watched Internet IPO’s will be those of Yelp (the reviews site) and Gilt Groupe (an online retailer), if they also get confirmed.

Those brave souls that decide to go public in 2012 should probably rely on proven tactics such as going for smaller deals (for instance 0ffering only 10% or less of the outstanding shares) and setting a conservative/lower offering price, to stimulate demand and increase chances of gain for investors.

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.

Valuation multiples in social media companies

By Xavier Forneris

In a recent post I discussed the issue of valuation for internet businesses in general and social networking companies in particular. I mentioned several examples of successful and not-so-successful initial public offerings (IPO’s) to illustrate the valuation issue. An IPO is not a requirement to make valid observations on the value of firms. When these companies are still private, what private equity, VC firms and other investors pay for a share of these companies, in private transactions with the founders (usually) allows to determine their overall value. The topic of social media valuation is not an acamedic but a very practical one. Implicit in my question is the concern that the public may be paying too much for a share of the social media boom and some have asked whether a new “internet bubble” reminiscent of the collapse of the dot-com market in 2000 was in the works.

And I’m sure many of you are familiar with the case of Skype, which eBay purchased in 2005 for $2.6 bn. At the time that represented 350 times Skype’s annual revenues. About 2 years later eBay took at $1.4 bn write down on its investment. In 2011, it was purchased by Microsoft for $8.5 bn, which meant a much more modest multiple (about 10, down from 350).

I must admit that I find the valuation multiples in the sector a little nerve-wracking. What matters is not the size of an IPO or how much a company is valued at, but what the valuation represents relative to the company’s annual revenue (sales). For example, when LinkedIn was valued at $9 bn after its successful IPO, this means that it was valued at 45 times its annual revenue of $200 m, or in “finance speak”, a multiple of 45. With annual revenue of $150m, Twitter‘s recent valuation at $7.7 bn means a multiple of 50. Zynga, the San Francisco-based maker of social games (such as CityVille and FarmVille) is due to have its IPO and start trading this coming Friday (Dec. 16) on NASDAQ. Zynga said it plans to sell 100 million shares at a price range between $8.50 and $10 per share. That would raise $1 bn, making it the biggest US Internet IPO since Google in 2004 (which I mentioned in my previous post) and giving the company a total market cap of $7 bn. For the nine months ended Sept. 30, Zynga claimed total revenue of $829 m.

If Facebook does an IPO in early 2012 that values the company at $100 bn, that would mean a multiple of 50, based on annual revenue of about $200 m. Based on its recent valuation at $75 bn, Facebook’s current multiple is about 37.5.

Looking at “typical” multiples, industry by industry, would help put things in perspective. Unfortunately, there’s no “commonly agreed multiple”. Different experts use different valuation methods. Valuation multiples vary from industry to industry; even businesses in the same industry sell for widely ranging multiples. Multiples also vary with the state of the overall economy, the stage of development of a company, or the reliability of its financial statements.

This being said, I want to quote a post by Michael Gravel on “Internet Application Software Business Valuation Multiples” (June 24, 2011):

A review of the 47 announced transactions within the Internet software and application software sector for the past eighteen months establishes a range (per individual announced deal) of business valuation multiples from .06x on the low side to 9.3x of gross revenues on the high side with the majority of the deals falling within 1.8x to 3.4x multiple of gross revenues.

These multiples, in an industry that is not too distant from the one we’re discussing, are much, much lower. But this does not necessarily mean that valuations for social media and internet firms are wrong or deceptive, nor that people behind these vlauations are over-optimistic or delusional. But it’s certainly justifies wondering whether investors are paying too much and whether such sky-high multiples can be sustained over a long period of time. Hence the concern, often raised in the blogosphere, of a possible “social media bubble”.

Another way of looking at this is to ask whether the social media companies will eventually realize the potential that investors have seen in them, in other words if their revenues will go up significantly, which would then bring the multiples to a more “reasonable” level. At least the companies I mentioned above have revenues. In his May 26, 2011 blog post “INFOGRAPHIC: The Soaring Valuations Of Social Networking Companies”, Kris Holt mentions two companies that have no revenues and a nice valuation (although not in the billions): Color Labs, valued recently at $41m and delicious valued between $15m-$30m, also with no revenues. Investors in these two companies are evidently betting that this situation will change and that they will be able to cash out.

I encourage you to read Kris Holt’s post on Scribbal, which includes a great infographic published by G+ (gplus.com). Below my post I provide the links for both Kris Holt’s post and for the original source of the infographic. I also welcome your views and comments on the tricky question of valuation for social media and internet businesses.

Sources / Read more:

http://www.imergeadvisors.com/2011/06/internet-application-software-business-valuation-multiples

http://www.scribbal.com/2011/05/infographic-the-soaring-valuations-of-social-networking-companies/

https://www.gplus.com/Editorial/Detail?seoName=INFOGRAPHIC-Is-there-a-Tech-Bubble&topicNames=Social-Media

http://www.minyanville.com/businessmarkets/articles/thestreet-zynga-zynga-ipo-internet-stocks/12/2/2011/id/38190

Social Media and Privacy

By Xavier Forneris

In a previous post (“Valuation of Internet Business”) I reported on the recent settlement between Facebook and the U.S. Federal Trade Commission (FTC). The FTC found that privacy claims made by Facebook were “unfair and deceptive, and violated federal law”. The social media would have shared users’ private data with advertisers in spite of a clear commitment not to do so. Another broken promise pertained to the access to videos and photos on deactivated accounts.

Let’s be clear: with this settlement Facebook is not admitting that it has violated the law. The company recognized, in a blog post by CEO Mark Zuckerberg, that “a small number of high-profile mistakes” were made but that it should not overshadown Facebook’s good record on privacy. And it has appointed two “chief privacy officers”. As part of the FTC settlement, Facebook has clear obligations. For instance it has to obtain users’ approval before it changes the way it shares the data. It will also be subject to an independent privacy audit, every 2 years for the next 20 years…Pretty embarrassing, although The Economist makes clear that Facebook is not the only company facing these measures: the FTC has also made Google and Twitter agree to regular independent audits, following accusations of privacy violations.

The Economist thinks that the regulator’s purpose may be to develop a regulatory framework that is stricter but still allows social media to innovate. It also warns that US Congress may be prompted to legislate on this and that European regulators are also looking into the privacy practices of social media.

Source/To read more: The Economist, Dec. 3, 2011

 

Valuation of Internet Businesses: the Google, LinkedIn, Groupon, Renren and Facebook IPO’s

By Xavier Forneris.

I’d like to talk about a subject that has intrigued me for a long time: What is the real worth of Internet businesses? After all financial valuation was designed in the pre-internet era for “brick and mortar” businesses, i.e., very different “animals”.

One way to answer this question is to look at IPO’s involving Internet businesses.

Google (NASDAQ: GOOG) set the bar high with its 2004 IPO that raised $1.9 billion and valued the company at $23 billion. Today, Google’s market cap is a massive $202 billion.

The first or one of the first social networking companies to go public was LinkedIn. Everybody was watching that flotation as a bellweather for the sector. LinkedIn’s IPO on May 19, 2011, was extremely successful, with an initial price of $45 a share, valuing the company at around $4.25 billion, around $1 billion higher than initial estimates. One day later the stock price had doubled, increasing the overall valuation to a whopping $9 billion overnight! Today, Dec.7, 2011 the stock (NYSE ticker: LNKD) closed at $74.26, well above its initial offering price, giving LinkedIn a market cap of $7.16 billion.

In early November (11/03/2011), Groupon, the discount-deal company, did an IPO with a $805 million float on NASDAQ (GRPN). The stock started to rise but has lost about 20% of its value in one month.

Does this mean that LinkedIn’s valuation was tactically “low-balled” to then exceed expectations? And does it mean that Groupon’s valuation was too optimistic?

Other Social Media IPO were complete disasters. Renren’s stock (RRN) lost 80% of its value in just 7 months, between May 5 and December 7, 2011. And the FriendFinder Networks (FFN)  stock dropped more than 90% during the same period. Their shareholders are probably not as happy as LinkedIn’s shareholders.

Now, it has been reported for a couple of weeks that Mark Zuckerberg who was known to be reluctant about floating Facebook is “warming up to the idea”. Although the exact timing and scope of a flotation are still unclear and no final decision made, rumour has it that the CEO/founder would be leaning toward an IPO between January and April 2012 that might raise $10 billion and would value the company at about $100 billion, about half the size of Microsoft whose current market capitalization is about $206 bn. Not bad for a social network started in 2004!

The $10 billion IPO, if confirmed, would be among the largest involving a US company (only 3 US companies had an IPO over $10 billion: AT&T Wireless Services, GM and Visa Inc.). It would definitely be the largest for any Internet or technology company.

Zuckerberg has been criticized for keeping Facebook private for too long. As mentioned by The Wall Street Journal (11/29/2011), companies often consider an IPO when they reach $100m in revenue. Far above this mark, Facebook now has close to $4 billion in revenue.

Listed companies have significant and strict financial disclosure obligations, one reason encouraging companies to remain private. The interesting twist here is that Facebook, even without an IPO, would have to publish its financial information in a few months, as soon as it will have more than 500 shareholders (SEC requirement). That is likely to happen about April 2012, which may be a factor behind the IPO consideration. Without an IPO, the company would have the obligation of disclosure but without the benefit of raising additional capital.

Another interesting fact is that on November 29, Facebook has reached a settlement with the Federal Trade Commission (FTC), the U.S. regulator, that had brought a number of charges against the company’s privacy practices. The FTC found that Facebook had “deceived” users by sharing personal data with advertisers in spite of a pledge to give such data private. I had not made the connection between that and the IPO until I read The Economist. The U.K weekly explains that the agreement removes an obstacle and clears the way for the anticipated “blockbuster flotation”.

Sources/Read more:

The Wall Street Journal, Nov. 29, 2011

The Economist, Dec. 3, 2011

LinkedIn Blog: http://blog.linkedin.com/2011/05/19/lnkd-bell-ringing/trackback/