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

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2011: Not a good year for Internet IPO’s. Does it matter?

By Xavier Forneris.

In a previous post, I talked about the “mixed success” of the Zynga IPO. Some observers were less kind and called it an IPO flop. Introduced at $10 (NASDAQ:ZNGA), the share price first surged to $11.50 before falling and closing the day at $9.50, or 5 percent less than the initial price! This was bad in itself but it 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.

The problem is, it’s not only Zynga. According to research firm Birinyi Associates, 19 of the 31 Internet and Social Media companies that went public in 2011 are trading below their offering price. A sobering observation if there is one.

According to Matt Linley (in one of his Dec 19 posts in Business Insider), 9 of the 16 tech companies that went public in 2011 were under-performing their IPO offering price by the end of the year. The difference in numbers between  Birinyi Associates (19/31) and Matt Lynley (9/16) may come from different definitions of “internet” and “tech” companies; or it may be that Birinyi’s research covers more markets/countries than Matt’s piece. Anyway, they reach the same conclusion: over half of Internet IPO’s in 2011 were disappointments.

I would now like to discuss why disappointing flotations matter. It’s not just that the folks who buy stock in the IPO lose money. After all, savvy (or connected) investors who play the IPO game should expect a certain risk level. But a more serious concern in my view is the ripple effect which we could see, both at national and local levels. Let’s start with the local level: in an excellent article recently published in the San Jose Mercury News – a great source of information for Silicon Valley aficionados-, Peter Delevett identifies some of the effects that disappointing IPO’s of social media businesses (such as Zynga) can have. In short, he explains that some firms that were contemplating a flotation may be thinking twice now. He adds that this could “dampen the wealth-generating effect a raft of initial public offerings can have on Bay Area employment, housing prices, and luxury auto (sales)”. This would be unfortunate, especially in our depressed economy, but Delevett then mentions other effects, which I view as more problematic for the economy. Delevett explains that if the venture capital (VC) firms can not take the start-ups public, they would have to either find buyers for them, inject more funds into them or, worse, “pull the plug” and let them die. It’s not only a one person’s opinion. As a matter of fact, the article quotes two Silicon Valley insiders who seem to share this sentiment:

Tim Young, founder of Socialcast, a start-up:

There are going to be a lot of walking dead start-ups that can’t close that third or fourth funding round

Mike Smerklo, CEO of Service Source:

“As soon as the public market investor starts to pull back, it has that ripple effect on the whole funding cycle”.

So, what will Internet, Social Media, and other Tech firms do in this difficult and unpredictable environment (which is of course largely influenced by, and reflects the state of, the overall economy)? Delevett identifies several possible developments:

  • A number of start-ups may decide to remain private, postponing or cancelling their flotation plans.
  • Start-ups will have to look for alternative source of financing.
  • Firms that decide to go public, may choose to sell a relatively small percentage of shares to “stimulate” demand. That was in a way the tactic implemented by Groupon and LinkedIn when they both offered less than 10% of their outstanding stock in their IPO’s. 
  • And other firms deciding to go public may set a lower than expected offering price for their shares, again in an effort to stimulate demand.  

I fully agree with Delevett. I hope that valuation will (finally) get the attention it deserves. IPO strategists will devote lots of efforts to identifying the “right offering price” but also the “right time”. Timing is a critical factor for IPO success. For instance, I agree with Matt Linley (see his post on LinkedIn’s IPO) that LinkedIn did its IPO at a much better time (May) than other Internet companies that went public later in the year and faced much more difficult market conditions.

How big of a problem is all of this? How many internet and tech firms are concerned? It’s difficult to say but one indicator we can use is the number of Internet companies that already filed to go public. According to Hans Swildens of Industry Ventures , also quoted in the same San Jose Mercury News article:

“There are 65 tech companies on file to go public , and it’s pretty clear that all these guys are not gonna be able to go out”.

But I don’t want to end on a sour note. To be fair, some Internet IPO’s were a success in 2011:

  • 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.

I will continue to follow these firms’ stock price in 2012 and beyond to see how they perform over time. I’ll also come back to the issue of excessive valuation and to the risk of a new internet bubble in future posts; this one was about the effect of “IPO flops” on the Internet/Social Media start-ups and their financing needs. In a next post I will also explain that it’s not just Internet companies that had a “bad IPO year in 2011”. As we will see, there were many disappointing and less-than-successful IPO’s last year, across industries. The ripple effects discussed here for Internet companies will largely apply to other sectors of the economy.

Note from the Author / Sources:

I want to thank Peter Delevett whose article has inspired me to write this post. I have borrowed quite liberally from his article – the version I have read in an East Coast newspaper was a little different and longer than the one that can be retrieved through the Mercury News website (title and link below). But I have used some of Peter’s quotes and ideas to support the argument I have been trying to make for the last month, namely that the hype and buzz we observe around social media can lead to irrational investment decisions and to discarding hard facts as irrelevant. I raise the issue of excessive valuation and expectations because the same pattern was observed before the 1999-2000 Internet bubble. As a big fan of Social Media and the Internet, I sincerely hope that we are not in a bubble. I will never try to predict a bubble; this is way beyond my competence, but I think the possibility deserves to be discussed. Following are the main sources I have used for this post: Peter Delevett’s article and two excellent posts by Matt Lynley. If you are interested in the above-mentioned issues, I strongly recommend that you read these 3 pieces.

Zynga’s flop could hurt some start-ups, Peter Delevett, San Jose Mercury News, 01 Jan. 2012. Link: http://www.mercurynews.com/business/ci_19618020?IADID=Search-www.mercurynews.com-www.mercurynews.com

Most Tech IPO’s this year were total busts, Matt Lynley, Business Insider, 19 Dec. 2011. Link: http://www.businessinsider.com/year-in-ipos-updated-2011-11

Why LinkedIn’s IPO was a big success when almost everyone else was a bust, Matt Lynley, Business Insider, 19 Dec. 2011. Link: http://www.businessinsider.com/linkedin-had-the-best-tech-ipo-of-the-year-by-a-huge-margin-2011-12