BIG….BANG…..BUST…………………

Well this has been the story of the overhyped, much anticipated Facebook IPO- the biggest tech IPO and the third largest IPO in the American history (after Visa and ENEL SpA). Facebook priced its IPO at $38 per share, valuing the social networking giant at $104.2 bn and making the offering worth $16.08 bn. However, everything has not been hunky dory for this IPO, which fell flat on its face, with underwriters rushing to perform the rescue act-buying the shares to keep the price above $38 on the listing day (18 May 2012). Morgan Stanley (lead financial adviser) bought 162 mn shares worth $16.6 bn. JP Morgan and Goldman Sachs holdings were $3.2bn and $2.4bn respectively by the end of the day. However, the share plunged 11% on the first trading day to $34.03 (21 May 2012).

Before we delve into the reasons for this downward spiral, let’s first ask the obvious question: Why was Facebook debut hyped so much? Well, the history gives you an answer.

·       Facebook IPO was expected to be a major milestone for the social media companies, just like Netscape’s IPO in 1995 and Google’s offering in 2004.  Netscape’s stock more than doubled, while Google’s stock was up by 18% on the first trading day. Facebook was expected to repeat the history, but the euphoria, unfortunately, was short lived.

·       Investors betting on a good first day pop, after impressive results from listing of Linkedin, Groupon and Yelp (none of the companies’ valuations as massive as Facebook’s). On the day of listing, Linkedin’s share price was up by 109%, Groupon was up by 31%, and Yelp increased by 64%.

HERE IS EXACTLY WHAT HAPPENED

IPO originally priced in the range of $28 to $35 per share, valuing the company at $95 bn at the higher end.

15th May 2012- The target price range is increased to $34 to $38 per share, valuing the behemoth at $104 bn.

16th May 2012- Additional 84 million shares are added to the offering, an increase of 25% over the original number of shares offered. These additional shares were offloaded by Company’s early investors like Goldman Sachs and venture capitalist Peter Thiel.

18th May 2012- Facebook prepares for the listing. NASDAQ bungles up the trading, which not only leads to a half an hour delayed start, but also pesters traders with technical glitches throughout the day.

18th May 2012- The stock added just 23 cents by end of the day. Company’s lead bankers, Morgan Stanley, Goldman Sachs and JP Morgan were forced to move into the market to keep the price above $38 level.  Morgan Stanley (lead financial adviser) bought 162 mn shares worth $16.6 bn. JP Morgan and Goldman Sachs holdings were $3.2bn and $2.4bn respectively by the end of the day.

NOW THE MOST IMPORTANT QUESTION- WHAT WENT WRONG?

1)     Ravenous Facebook insiders (including the early investors in the company)- Overloading the market with too many shares without gauging investors’ appetite.

2)       Problems with NASDAQ’s IPO mechanism.

3)     General Motors announcement to cease advertising on Facebook, just days before the IPO hit the markets. This would wrench $10 mn in annual ad spending from the Company, which earns 85% of the revenues from advertising.

4)    Company’s lead underwriters, Morgan Stanley, Goldman Sachs, and JP Morgan as well as the co-manager Bank of America all of them cut their earnings estimates for Facebook in the middle of the IPO roadshow. Quite astonishing, but all these revenue estimates were converging to more or less the same figure of $4.8bn from an initial estimate of $5bn.

5)     The fact that the revenue estimates were cut and unanimously by all the underwriters hardly seems to be a coincidence. The lead underwriters of a company work very closely with it and invariably have inside information. So the revenue cut did point to the fact that “All was NOT well” with Facebook

6)    The cut in estimates by these banks was not revealed publically but was only communicated to sophisticated institutional investor verbally, leading to controversial selective dissemination of vital information.

7)    The result was that institutional investors wanted to buy the IPO at a much lower price, around $32 but retail investors, totally unaware of the revenue cut were enthusiastic, pricing the IPO at $40-$42. The Lead underwriter Morgan Stanley then decided to quote the IPO at $38 per share.

8)       And the last but not the least- a very unrealistic valuation of whopping $104 bn. While the other tech giants like Apple and Google are trading at 12X and 14X the 2012 estimated EPS respectively, Facebook is trading close to 58X 2012 estimated EPS (Source: Bloomberg). Now consider the following: FB’s q-o-q revenue growth has been slowing down since 1Q 2011; the advertising revenue growth has been muted in 1Q 2012; as more and more people switch to mobiles from web, FB’s revenue per user might dip; and since the richest people are already on FB (the target for advertisers), the next wave of 2 billion users is likely to be less valuable monetarily. Acknowledging all the aforesaid factors one is compelled to ask- “IS FACEBOOK REALLY WORTH $104 billion?” The answer in all likelihood is “NO”

        Mark Zuckerberg, the Founder and CEO of FB, had told early FB employees that he wanted to stay private forever. Looking back at all the brouhaha around the IPO and its failure that ensued, one can only wonder if he wants his baby back- unscathed and all for himself.

As for the savvy investment bankers, who expected to burnish their reputation with this IPO, should rethink about their role - it’s worth a thought, SURELY….