Joe Nocera, New York Times columnist, wrote an article about the Facebook IPO last week. In a nutshell, he concluded that FB was a “brilliant disaster.”
Nocera stated that because FB received so much money before its stock price cratered, the best result came to fruition. Large institutional investors who usually receive out sized-allocations of shares in “hot deals” were unable to flip stock at a higher price. Ultimately, FB and its original stockholders were the only beneficiaries in this landmark transaction.
A little background is necessary to understand Nocera’s perspective. He referred to an IPO by Splunk, “an eight-year-old, money-losing data analytics company that went public five weeks ago.” Its stock was priced at $17/share; on the first day of trading, it closed at over $35/share, a gain of over 100%. Since then, the stock declined for a while and rallied back to the opening price.
Nocera’s contention is that “if the bankers had done a better job of pricing the shares, and had come closer to the $35 amount that investors were willing to pay, the company would have reaped twice as much.” And wouldn’t it be better if the company received more money than third party invetors? The parties who made huge profits were favored institutional investors who received the stock at $17/share and immediately sold it at double the price. No doubt, very few retail investors were able to cash out to the same extent in this cream puff deal.
Anybody who knows anything about the IPO business knows the following:
Historically, tech IPOs dating back to the Internet bubble have done very well on opening day. So, depending upon the quality of the company and the pre-IPO marketing, the price of a tech IPO can increase significantly. Stock movements in the months and years following these IPOs are all over the map. In any case, it is folly to think that every tech deal will increase 50-100%. Underwriters and the company are much better off if the price increases by a smaller amount. The company gets an appropriate price, and investors can share in some upside as a bonus for supporting the stock in the IPO. Moreover, the same investors will likely support future stock transactions by the company. Investing in IPOs is risky business and FB proves this fact, as the most sophisticated investors in the world lost their shirts. There are no guarantees for any investors. Institutional investors understand this; unfortunately retail investors do not always appreciate this reality.
Splunk was a reincarnation of the hot deals that took place during the Internet boom years around the Millennium. As with many tech companies in those days, Splunk has not earned a profit after several years of operations, and yet, it hit the market like a thunderbolt. Exuberance resulted in a large first day gain. However, Splunk only raised $225 million, as compared to $16 billion by FB.
FB was far too large to double in price in one day, which would have increased its market capitalization from $100 billion to $200 billion. Investor expectations were more likely in the 10-20% range.
If an investor, be he institutional or retail, believed all the pre-IPO marketing and took a flier with FB, he got what he deserved especially after the company “tells” during the week preceding the IPO. Those clues included an unwarranted increase in the number of shares offered by the company, an overly optimistic higher offering price, questions about FB’s mobile business and skepticism about FB’s advertising model.
FB stock has settled in at a price somewhat lower than the IPO, so many investors are disgruntled (some of which are complaining about unfair dissemination of information). Nasdaq must still explain how it botched the trading of FB shares in the first couple of days. Facebook should tell us why its mobile business will not significantly decrease its revenue growth prospects and why its advertising strategy is sound. The underwriters will be second-guessed about their performance in the IPO. And finally, Congress will feel obligated to investigate and waste time that should be spent fixing the economy and increasing jobs in America.