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