The saga of Facebook (FB) continues with all sorts of rumors and business concerns circulating around Wall Street and in the media. Here we will discuss some of the most important issues.
Setting an IPO valuation/opening price is dangerous business for underwriters as the company and its new investors are at odds. When one gains a price advantage, it comes out of the other’s pocket. For months prior to IPOs, bankers discuss valuations with the clients, which will ultimately determine offering prices. In short, all companies want the highest price. If a company is issuing ten million shares, every $1 change increases or decreases the gross proceeds by $10 million. In the case of FB, the numbers are exponentially higher; it raised about $16 billion at $38/share, so each point change was really significant ($421 billion).
However, a company should also want to satisfy its shareholders. For FB, it is particularly important because its original investors and its employees still have millions of shares to sell in the near term. A poorly orchestrated IPO could leave a bad taste in the mouths of investors for years to come, which then would negatively impact future stock offerings.
What do new investors want in an IPO? Simply put, they want the company and its underwriters to “leave something on the table.” What does that mean? Enough “something” so the stock price increases by 10% or more (for FB) after it starts trading. Other tech companies, in recent years, had gains significantly greater that enriched those who received shares in the IPO. But, it would be absurd to expect FB’s stock price to rise 30% or more because of its huge market capitalization. The moral of this story is that an IPO should not be priced to its maximum; if it is, the issuer will likely generate bad will with investors.
Prior to the offering, the proposed price of the FB IPO was raised to $38/share, and the size of the offering was increased as well. This should not have happened unless demand was overwhelming and/or the prospects for the company had increased. The reporting has been fuzzy about investor demand in the hours before the offering; some say demand was very strong and then it dissipated at the offering. Suspicious?
There were no positive business developments during the week preceding the IPO. But, there was one significant negative event. General Motors cancelled an ad order of $10 million raising questions about the “pop” in FB advertising, the company’s largest revenue source. And, analysts are becoming more concerned about the number of FB customers using mobiles to log on to the company’s site. Unfortunately, FB advertising does not appear on mobiles, so this user activity does not generate revenues for FB.
CNBC conducted a debate today that included Michael Wolff, a critic of FB. In a nutshell, Wolff said the company currently receives 82% of its revenues from advertising, and apparently FB’s form of advertising is not as popular with advertisers as other types of Internet advertising, such as Google. Wolff’s conclusion was that FB must diversify its sources of revenues in the immediate future or lose even more of its investor appeal.
New “takes” on the IPO distribution debacle continue to arise. Usually, in a hot IPO, one that are expected to rise significantly after the offering, institutional investors put in oversized orders and expect to be cut back because of demand. The opposite happened in the FB IPO; some institutional investors received their full requests. This was a signal that demand for the stock was weakening. It was exacerbated by the Nasdaq’s inability to confirm trades in FB during the first day, which really spooked the market and put downward pressure on the company’s stock price.
On Tuesday, FB closed at $31.91/share, up just under a dollar for the day. Hopefully, this is a sign that the stock is trading efficiently and that buyers are seeing value in FB at the current price.
Future short term movement in the stock will depend upon how well management responds to the fundamental problems being cited by analysts, the most important one being the company’s ability to increase and diversify its revenue base. Soon after, FB’s earnings report will be front and center. If earnings do not increase at a rapid pace, the stock will have problems. And finally, the stock sales by insiders and employees will begin in six months. The ability of the market to absorb these shares will be based upon the previous two items mentioned above.