On May 18th, 2012 Facebook had its initial public offering. The company offered 421,233,615 shares priced at $38.00. This enabled Facebook to raise about $16 billion on the first day of IPO. The company was valued at about $104 billion at its listing. The approximately $16 billion capital raised was split in the following manner: $176 million was paid for underwriting discounts and commissions $6.764 million proceeded to Facebook $9.066 million proceeded to selling shareholders Thus, the company received only 37% of the cash raised overall, while the rest of the money went to the underwriters and to the selling shareholders. Initially it was planned to offer only 337 million shares priced at $31.50 which would value the company at about $85 billion, however due to high market demand the amount of shares and the price was increased 2 days before the IPO.
Facebook’s IPO has been grossly overpriced. During the first day of IPO the stock market closed with only 0.6% rise in stock price. In subsequent days the price fell dramatically and the price at 1st November ’12 is $21.21 an underperformance of 56%. Facebook paid 176 million to underwriters which is merely 1.1% of total 16 billion of the revenue Facebook raised during the IPO. However, taking into account the Facebook’s direct cash raising of from the IPO was 6 billion, the underwriter’s fee raises to 2.6% of Facebook’s proceeds. This is quite low as compared to 3.6% median fee on the 10 largest U.S. initial offerings in history before this one. With larger IPOs, banks are often willing to take a small percentage fee and can use high-profile offerings to help land more IPO mandates later on.  Worth noting that as Facebook’s price was going down, Facebook’s CEO Mark Zuckerberg sold 30.2 million shares earning $1.13 billion and was followed by Facebook director Peter Thiel who sold 16.8 million shares for $633 million.
Valuation plays a big role in judging the price of an IPO. Revenues are a very important consideration – Facebook earns most of its revenue through advertising which can be very uncertain in the future because as this revenue stream is historically volatile. Facebook will need to find additional revenue streams that is less volatile, if it is justify such a high valuation. In the first quarter of 2012, Facebook’s revenue had increased, but Net Income went down. Revenue was $1,058 billion, up 45% year over year from $731 billion though Net Income decreased from $233 million to $203 million. Despite these facts, the company and underwriters went ahead with the listing of the company. Over this same period, Facebook had generated high anticipation and demand for its stock. This high demand influenced the elevated IPO price of $38/share driving the IPO valuation of Facebook to $104 billion. Facebook’s IPO valuation was at the same market capitalization levels as McDonalds, Amazon and Bank of America (as the AP report indicates).The graph below shows Facebook’s valuation in comparison to other large internet IPO’s.
Deal Size (M USD)
Valuation (M USD)
# of shares (mill.)
Offer price (USD)
Facebook 18-May-12 $15,998 104000 421.2 $38.00 Google 18-Aug-04 1,666 23,000 18.6 $85.00 Alibaba 6-Nov-07 1,500 7,800 858.9 $1.74 Yandex 23-May-11 1,304 8,400 52.2 $25.00 Shanda Games 24-Sep-09 1044 3,300 83.5 $12.50 Some may argue that Facebook was correctly valued considering Facebook’s large user base of over 901million. Facebook is considered the largest internet IPO. And to further analyze the IPO pricing, a comparison between Facebook and Google’s IPO is appropriate. Both Facebook and Google have transformed the way internet is used. Advertisers need both platforms to reach their customers. Both companies also experienced a declining growth rate of revenues prior to their IPO. However, unlike Google, investors are worried about the effectiveness of advertising as a sustainable revenue source. Facebook receives approximately 85% of revenue through advertising and 15% through subscriptions (Forbes). Facebook is increasing its presence on the mobile platform, but this is decreasing the scope of reach for advertisers. This example shows that Google is providing more sustainability for investors whilst Facebook has yet to find a solid revenue generation strategy – which implies that Facebook IPO, in principle, is overvalued as the largest internet IPO. Conclusively, the IPO pricing can be judged as being too high.
Morgan Stanley & Co LLC was acting as the lead representative underwriter. Based on Facebook’s prospectus, the list of underwriters is as follows:
Number of shares
Morgan Stanley & Co. LLC
162,174,942 J.P. Morgan Securities LLC 84,878,573 Goldman, Sachs & Co. 63,185,042 Merrill Lynch, Pierce, Fenner & Smith Incorporated 27,380,185 Barclays Capital Inc. 27,380,185 Allen & Company LLC 8,424,672 Citigroup Global Markets Inc. 9,477,755 Credit Suisse Securities (USA) LLC 9,477,755 Deutsche Bank Securities Inc. 9,477,755 RBC Capital Markets, LLC 4,212,336 Wells Fargo Securities, LLC 4,212,336 Blaylock Robert Van LLC 673,974 BMO Capital Markets Corp. 421,234 C.L. King & Associates, Inc. 631,850 Cabrera Capital Markets, LLC 421,234 CastleOak Securities, L.P. 673,974 Cowen and Company, LLC. 421,234 E*TRADE Securities LLC 210,617 Itaú BBA USA Securities, Inc. 210,617 Lazard Capital Markets LLC 421,234 Lebenthal & Co., LLC 673,974 Loop Capital Markets LLC 673,974 M.R. Beal & Company 673,974 Macquarie Capital (USA) Inc. 421,234 Muriel Siebert & Co., Inc. 673,974 Oppenheimer & Co. Inc. 421,234 Pacific Crest Securities LLC 421,234 Piper Jaffray & Co. 421,234 Raymond James & Associates, Inc. 421,234 Samuel A. Ramirez & Company, Inc. 631,850 Stifel, Nicolaus & Company, Incorporated 421,234 The Williams Capital Group, L.P. 589,727 William Blair & Company, L.L.C. 421,234
The underwriter is the organization that is responsible for pricing, selling, and organizing the issue, and it may provide additional services. With direct public offerings, there is no need for an underwriter. Underwriter will assist in the preparation and submission of appropriate SEC filings, helping potential investors make informed decisions about an offering. All underwriters are required to exercise due diligence in verifying the information they submit. In addition to SEC filings, underwriters will create a preliminary prospectus that will become a major part of the issue’s marketing campaign. Facebooks underwriters’role was to purchase Class A common stock and sell them to the public at the offer price of $38 per share in addition to other official underwriting responsibilities. The underwriting agreement stipulated that underwriters were to pay for Class A common stock offered by the prospectus. They were to also adhere to certain legal matters with regards to purchasing the stock. On the first day of trade, NASDAQ experienced technical errors that led to delays and errors in Facebook trade. The underwriters prevented a potential tragedy by scooping up shares of the company during the NASDAQ situation. This propped up the stock, keeping it above the $38 offering price through most of the day.  The practice is standard during IPOs, especially high-profile ones like Facebook. The big banks buy into a wave of selling as a way to prevent their customers from suffering big losses. The group of underwriters led by Morgan Stanley helped prop up shares after NASDAQ experienced technical problems processing trades. Underwriters have conflicting objectives on the day of the IPO when the stock price appears at risk of falling below the issuing price. Their obligation to the firm and their reputation, pushes them to support the stock, especially around the IPO price.
Morgan Stanley (MS) and other underwriters have put their reputation at risk, given the price of Facebook fell below expectations.. One of potential consequences is the loss of their best customers. The underwriters having over-estimated the market demand, are now perceived as being too greedy to issue excessive volume of stock and maximizing the price for their own benefit. A loss of reputation and the loss of via an over-estimated price transferred to the disappointed investors could result in many quitting the market.
Due to the reputational damage incurred, Facebook and its underwriters may lose their clientelle thus reducing their will to continue investing. Furthermore, during Facebook opening day, the NASDAQ exchange trading system failed, and it was delayed for half an hour before they start trading and with many of the orders either not being able to be changed or performed. This further intensified the fear and uncertainty of investors due to over-pricing.
Facebook’s reputation has been damaged due to the sloppy process of issuing IPO and the underwriters maximizing the IPO price. The rapid decline of the stock price after the release IPO is a direct result and true price indicators. This will make investors in subsequent stock offering more vary and cautious.
Facebook and its lead underwriters Morgan Stanley, Goldman Sachs Group Inc., JPMorgan Chase & Co. and other underwriters are being sued by investors and various other stakeholders because of the misleading information in the purchase of Facebook IPO. The shareholders claimed that Facebook and its major underwriters concealed “a severe and pronounced reduction” in revenue growth forecasts – due to the expansion of mobile devices users rather than personal computers. Though Facebook has not published their advertisement revenue split by users who log on through mobile devices, this effect was forecasted to reduce advertising revenues. According to the complaint Facebook told its bank underwriters to “materially lower”  it’s forecasts for the company based on this. The lawsuit also accused that Underwriters reduced the estimation of Facebook revenues forecast for the second quarter and whole financial year of 2012, but they did not inform public investors before the IPO. Additionally, the underwriters reduced their earnings estimates dramatically during the roadshows and but were told to disclose this to a select group of investors only, not all prospective investors.
We can say that Facebook’s valuation was credible because of the company’s great reach, but, no one knows how Facebook will be able to monetize that reach. As an example, Google, at that time, had an attractive standard price-earnings ratio – around 15 to 20  . That was where Facebook supposed to be in terms of price to earning as a comparable. Among the factors driving the increased price initially, was that there were many investors interested in Facebook, especially among individual investors. According to Mona DeFrawi, chief executive of Equidity, an IPO consultancy. Many people didn’t buy Facebook because it’s an investment, but because they feel like they want to own a piece of history  . Also, the demand surpassed most analysts’ expectations in spite of growing criticism of the social network’s mobile strategy and advertising business. To make one example, General Motors was removed from Facebook’s paid advertising platform. The company’s $104 billion valuation could not be supported by financial fundamentals and hence doubts were raised over whether the company will develop enough new and effective advertising tools or other revenue streams to match investor expectations. In order to succeed Facebook not only has to have an optimistic valuation, they really need a great performance so as to avoid the stock price declining due to these expectations. Other reasons to conclude this:
In Wall Street the trend is very important and considering that 19 social media IPOs debuted last year, we should at least see how they performed. No less than 82.4% of last year’s social media IPOs are now trading below their opening day prices. And 57.9% (or 11 out of the 19) are trading below their offering prices. Two of the most notable flops were Zynga (Nasdaq: ZNGA) and Groupon (Nasdaq: GRPN). Zynga is the world’s leading social game developer with 227 million average monthly active users in 175 countries. It’s behind the popular social games like CityVille, FarmVille, Mafia Wars and Words with Friends. Zynga began trading on NASDAQ December 16, 2011. It priced its shares on December 15 at $10 per share. The stock bombed in its first trading day, closing down 5%. Zynga’s stock jumped on February 3, 2012 trading at $13.39 per share, climbing 26% in the two days following Facebook’s IPO filing on February 1, 2012. Zynga is highly dependent on Facebook, as that’s where the majority of its games are distributed, and the companies have had a close relationship for years. Facebook reported that 12% of its revenue comes from Zynga and hence could have been seen as a proxy for Facebook’s performance. As for the latter (Groupon), it zoomed 55.7% higher on the first day of trading. Within weeks, though, the stock collapsed to trade below its IPO price of $20 per share. Groupon recorded a $389 million loss in 2010 and $102 million in the first quarter of this year. This trend will continue as Groupon has reported that expenses will increase substantially in the foreseeable future. The reasons to avoid Facebook’s IPO extend beyond Wall Street’s poor reception for social media stocks as a group.
When it comes to investing in IPOs, investors think in the future of the company. And if the company can’t keep growing, their investment is doomed. In about four years’ time, Facebook’s user base went from 66 million to 800 million. If Facebook grows at the same rate over the next four years, its user base would hit 9.7 billion. Realistically, Facebook should top one billion users this year, which is a growth rate of about 25%, year-over-year. In other words, the growth is already waning. And slower growth doesn’t translate into higher stock valuations. Especially since Facebook is already overpriced.
Facebook Founder and CEO, Mark Zuckerberg, contends he focuses on products over dollars. As he said in an interview with The Wall Street Journal, “The thing to take away isn’t that we don’t care [about business]. People for years were asking me why aren’t we trying to make more money. I would say I’m trying to build a business for the long term¦”  Not focusing on profits is fine and even more when you’re a private company. Not so much when you’re a public company. Wall Street obsesses over profits. As a result, share prices ultimately follow earnings. Even if Zuckerberg immediately finds this out, Facebook’s IPO is still grossly overvalued. Consider: Internet giant, Google (Nasdaq: GOOG), trades at a market cap of about $200 billion and generates about $9.6 billion in profits. That means for Facebook to support its $100 billion valuation it would need to generate about $5.3 billion in profits. To profit from it will require buying high and selling higher.
Facebook close after its first day of public trading with a rise of 0.6%. According to a number of reports a number of underwriters sold out on the first day and also a number of investment banks also supported the stock to ensure that it remained steady at the end of the day’s trading. Some individual investors may have brought into the hype around the stock price or not wanted to miss out on first day IPO gains experience recently by LinkedIn. The performance since the IPO has been substantially down despite a recent rally, closed at $27.XX on 30th November 2012. At around 70% of the issue price this has left IPO and early public stock investors with a large percentage paper loss. Some analysts before the listing made comparisons to the largest rival social network, LinkedIn which has increase over 130% since listing; in fact no major stock analyst forecast a decline in the stock price – raising moral hazard issues given the number of underwriters involved  . Interestingly Facebook has rallied over the last month and Facebook met quarterly earnings per estimates at 6 cents. Concensus price expectation is $29 ( at 30th November 2012)  above its current close of $27.32 and the preference is for a Strong Buy.
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