Defending the Facebook IPO
“Victory has a thousand fathers; defeat is an orphan.”
– President John F. Kennedy
Somebody fucked up. Actually, it’s clear already that lots of people fucked up. Lead underwriter Morgan Stanley screwed the pooch by pricing the stock at $38, only to see it drop to $31 within two days and still sit some 13% below its offering price as of Thursday’s close. The investment bank also stands accused of letting favored clients know that its analyst was reducing growth estimates for Facebook (FB) stock ahead of the IPO, behavior that is not only unethical but likely a violation of SEC regulations.
Mark Zuckerberg fucked up too. Like Morgan Stanley, he is being sued for failing to disclose material information to smaller investors. His reputation has taken a hit with larger investors, too. According to Wedbush Securities analyst Michael Pachter, Wall Street was so hurt that Zuckerberg wore his trademark ‘hoodie’ to analyst meetings – instead of the standard suit and tie normally required of people fleecing “muppets” out of billions of dollars – that it has refused to step in as Facebook stock has fallen. To top it off, he got married the day after his company went public at a nearly $100 billion valuation. Doesn’t he know how much tail eight or nine billion can buy?
Don’t forget the NASDAQ exchange. Chosen by Facebook for its listing over the traditionally more powerful New York Stock Exchange, NASDAQ saw its systems simply overwhelmed by the volume during Facebook’s first day of trading. Traders spent hours unsure whether orders in FB stock had been filled, an astounding development in a market now dominated by high-frequency trading, in which stocks are bought and sold in milliseconds. (Indeed, HFT was one of the culprits blamed for the NASDAQ glitches.)
Who else fucked up? Oh yeah, me. “There is too much hype around Facebook, too much potential in the company, and too great a story to sell for the stock to slip up early in its existence. Given that the IPO is already oversubscribed – meaning many more shares have been requested than are available — demand for the shares will most likely support the stock’s price for the near future,” I wrote on May 14th. In my defense, I might have been right, had not the above culprits screwed everything up. One hedge fund manager told Business Insider that the NASDAQ issues, and questions concerning order fulfillment, likely saved retail investors from themselves. “This should have been a blockbuster,” he told the website, lamenting the lost momentum from consumers – the same momentum I argued would hold up the stock. “Think about a guy who was going to put five grand on this,” he added. “You go to Vegas and $5,000 on the roulette wheel and it breaks, it’s like, hold on, I’m not going to do that.”
I also argued that Wall Street would step in to support the stock, and it clearly did so on Friday, with large orders coming in every time the stock neared the $38 offering price. By Monday, the Street did not have the ammunition or the will to continue to prop up FB. Whether it was the overwhelming bearish sentiment – no doubt driven, in part, by the NASDAQ mess – or their desire to get revenge on Zuckerberg for snubbing his nose at their dress code, the Street could not – or did not – keep Facebook above $38 per share. The media narrative turned on the company and the stock, and with retail investors pushed to the sidelines, the “Facebook is overvalued” theme took over, driving FB’s share price down.
While Facebook’s true value remains a source of argument, one thing everybody seems to agree on is that its IPO was a massive clusterfuck. The “botched IPO” was marred by “embarrassing technical glitches,” wrote CNBC’s Scott Wapner. “Fumbled,” wrote the Washington Post. Vanity Fair‘s Juli Weiner called it “a disaster.”
But let’s try a simple thought exercise. For the sake of argument, suppose that Facebook was priced on Friday not at $38, but at $28 per share. Suppose that NASDAQ didn’t botch trading execution that day, and the stock ran to, say $42 a share (its actual Friday high) before settling back down around $34 per share. Over the next four days, the stock drifted to $31, before closing Thursday at $33.03 (its actual Thursday close.) What would the story look like then?
Of course, it would be a lot different. Morgan Stanley would likely be congratulated – instead of scorned – for pricing the IPO relatively well, creating a pop in the first day of trading, while also providing near-maximum return to Facebook, its employees, and its early investors. Zuckerberg would be considered a new tech titan, instead of an immature hoodie-wearing douchebag. The NASDAQ would retain its image as the hip, tech-dominated exchange whose computers were out-competing the stodgy old NYSE with its antiquated human specialists running around the trading floor for the benefit of European tourists. Most importantly, I wouldn’t look like an asshole for recommending a stock that fell 20% in three days.
But, really, what would have changed? About $4.2 billion – the $10 per share price difference, multiplied by the 421 million shares released in the IPO – would have been gone somewhere different. Facebook itself would have received $1.8 billion less. Given that CEO Zuckerberg spent $1 billion on Instagram, a photo app that literally has never generated a single dollar of revenue, this is probably a good thing for the next entrepreneur who can devise a worthless but popular software program. Zuckerberg himself got an extra $300 million at the $38 offering price; his proceeds from the offering were, according to public filings, going to pay taxes, so now the debt-laden US and California governments get a bit more cash. The Wall Street banks would have earned about $15 million less at $28 a share, but seeing as how Morgan Stanley alone made an estimated $100 million in trading the Facebook debacle, that’s peanuts. Hedge funds likely lost out on potential trading profits from a lower-priced offering, as they would have used their inside position to gain IPO shares and then dump then on retail investors during the first day of trading. Smaller investors allocated shares through E*Trade, Fidelity, and the like would have done better at a lower offering price – they have already lost some $630 million in paper profits, according to the Boston Globe. But bear in mind, as the hedge fund trader above argued, that the NASDAQ trading glitches on Friday likely kept some retail investors out of the market – much like their hedge fund brethren – and probably saved some dough there. It’s also important to remember that many so-called “small investors” are lawyers and dentists and other jerkoffs you went to high school with.
So, long story short, all the criticism of Facebook, all the commentary and teeth-gnashing an analysis of the “fumbled,” “bungled,” “botched,” disaster of an offering really boils down to about $4 billion of paper profits that went from one group of rich assholes to another. Half of that money goes to Facebook as a company and Zuckerberg personally, who combined earned an additional $2 billion in the offering that everyone seems to agree was such a mess.
The hype leading up to Facebook’s offering has, amazingly enough, been surpassed by the idiocy following the offering. The best example of Wall Street’s skewed sense of markets comes from Wedbush’s Pachter, the analyst who apparently assigned a multi-billion valuation to Mark Zuckerberg’s hoodie. “The flop is 100% a function of a supply/demand imbalance…” he wrote in an email. “There is no question that had this deal been 1/3 the size, the market would have absorbed it and the deal price would have held.”
Pachter is correct. A smaller deal would have held. But for how long? Eventually the additional shares would have to be dumped on the market, causing selling pressure. (The share price of key Facebook partner Zynga was hurt badly by a secondary offering earlier this year, after they followed a strategy similar to that recommended by Pachter.) Pachter’s logic is typical Wall Street – if only they had put out fewer shares, we could have better manipulated the stock price. But that can’t last forever. Facebook is worth what it’s worth. Right now, it’s worth $70 billion.
At the end of the day, Facebook outsmarted investors. Had the IPO gone in a way considered “successful,” new investors would have more money. But it “failed,” giving the company and its founders, financiers, and employees an extra few billion. God willing, we can all fail that way.