Why Facebook’s IPO flopped

Published: June 5, 2012

A lot of investors are wondering what exactly changed to cause this downward spiral. ILLUSTRATION: SIDRAH MOIZ / ZAHRA PEER

The initial excitement associated with this biggest ever deal for Nasdaq has faded away. Facebook’s share prices continue to plummet with the share price reaching a new low of $26.9 today. The original price set by the Facebook team was $38.

The drop in Facebook’s share price wiped more than $11 billion off the company’s market capitalisation with Bloomberg declaring that “the IPO produced the worst five-day return among the largest US deals of the past decade.”

The latest news that disgruntled shareholders are furious over Facebook’s IPO performance, and cannot wrap their heads around how the country’s second largest IPO ever flopped. They are threatening to sue Facebook and this is not helping the situation at all.

One of the biggest IPOs in history, Facebook’s team failed to capitalise on the hype associated with this event.

Everyone is wondering as what went wrong, in a matter of few days, as the rest of the stock market rallied in the same period. A lot of investors are wondering what exactly changed to cause this downward spiral; one thing is clear, nothing seems to have changed in the fundamentals of the business. Facebook still has more than 900 million users and this IPO theoretically should have only enhanced the reputation of the business.

However, this did not quite happen, and there is some very interesting news coming out, despite no official verdict from either Facebook executives or even Morgan Stanley – the lead underwriter in this IPO. Surprisingly, there is complete silence from both sides which is only making the things worse for the stock price.

One significant and highly unusual event that took place was when “Facebook’s lead underwriters Morgan Stanley, JP Morgan, and Goldman Sachs, all cut their earnings forecasts for the company in the middle of the IPO roadshow,” as reported by Reuters. 

This was a highly negative move, hardly ever heard of in recent history.

The main reason behind this seems to be that an inside executive working for Facebook was aware of the business’s performance, and asked them to do so. The second quarter’s performance was expected to be below the original estimates set by the analysts.

However, here comes the shocking news; this piece of vital information was only disclosed to the underwriters, which resulted in the estimates being cut and the information subsequently being only shared with the sophisticated investors, verbally, who were interested in buying Facebook shares. This, according to my layman knowledge, qualifies as ‘insider trading,’ a crime for which Martha Stewart was sent to jail.

The small investors were left completely out of the loop. This discrimination is not only unfair to the small investors but also against the fundamentals of securities laws.

Naturally, as the news of this event is spreading, it is having a deeply negative impact on the share price of the company. Interestingly enough, no one can predict how face the stock price is going to plummet.

Also adding to the steep plummet was the issuance of an additional 25% of shares – a tweak added just three days before the IPO, due to an ‘extraordinary’ demand. These shares came from the early investors such as Goldman Sachs and venture capitalist Peter Thiel. This, naturally, raised the alarm bells for new investors as they began to wonder why these firms would not like to hang on to these shares if they believed the stock value will rise. This resulted in a lot of emotional trading resulting in the share price dropping to levels no one expected even a few days ago.

Facebook’s IPO was a litmus test for all other social networking sites. It raises the question as to whether there is enough potential in similar business models to go public. Groupon’s poor performance in the stock market these days is suggesting otherwise.

So far, even though Facebook has not failed, we can safely say that the IPO has not been a success of the magnitude that was expected from it. The stock valuation of $28 to $35 was the original price set by Facebook, while later on the range was increased to $34 to $38. This raised the question as to whether the firm behaved ethically or not; did they know that the analysts had lowered their estimates?

Anti-Wall Street Campaigners have been given yet another reason to question the integrity of the investment bankers and financial institutes. Wall Street insiders, yet again, managed to get preferential treatment in the form of privileged information while the the small individual investor suffered at the hands of one of the biggest IPOs in history.

Farhan Rashid

Farhan Rashid

Is a Chartered Management Accountant by profession with a CIMA qualification and a Master's in Finance from a leading UK business school. He has been based in London for the past twelve years and works in the stock brokerage industry, though he is originally from Islamabad. He tweets @farhanrashid76

The views expressed by the writer and the reader comments do not necessarily reflect the views and policies of The Express Tribune.

  • Adnan

    The main reason for the IPO’s failure was that the share price was over-valued for a corporation that does not produce anything. Its a service and there’s no physical existence to back such a high share price. Recommend

  • abhi

    i don’t think facebook share is even worth $26. There is no way company can expand its business and revenue. there are lots of other sites offering similar services and people will start using them instead of sticking to facebook.Recommend

  • Omar

    Agree with your points. In the video on the blog, Anant Sundaram keeps on saying the Facebook had been providing earning updates till the last day, but my question is, why didn’t Morgan Stanley revise the introductory price of $38? and change it to a lower value of say $23 – $25? That would have kept the speculation away which history has shown causes a lot of long term damage to a company. Agree with the writer that the idea was to benefit a select set of institutional investors at the cost of the general public!Recommend

  • Omar

    @Adnan:

    I doubt if the company not being in physical production of goods is a cause of failure – we live in an internet economy, the organisations assets are no longer just ‘physical’. The crucial aspect in this scenario is to conduct proper ‘diligence’ in coming up with the valuation and this is where i think the underwriters weren’t careful. In my opinion it is better to have a slightly conservative initial valuation rather than over valuing a stock which leads to speculation, in turn harming the company’s prospects.Recommend

  • AQ Moghal

    I agree with Adnan, EPS (Earning per share) was 104% for the IPO price of 38 which is roughly 5 times more of Google.. Or 2.5 times more of Apple.
    so In my opinion .. Very humble opinion the fair price to buy this stock should be under $6 for a relative comparison of google or little over $12 if you compare it with Apple… Which I wouldnt because apple is not a social media company but a leading tech company that moves the nasdaq… Thats why I listed it here…
    AND this is not an investment advise..Recommend

  • http://howtodaytrade.biz Berg Canon

    Overpriced and too many people been holding onto shares for too long a time. The NQ mishap didn’t help much either. The question is is it still a good investment? I wrote a piece on this covering some aspects that no one else has covered. Judge for yourself http://howtodaytrade.biz/is-facebook-still-a-good-investment/Recommend

  • FS

    Martha “Stewart” was actually sent to jail. Fresh reports suggests that it will continue the plummet and stabilize near low 20s. May be that’s why no one is defending the Stock Price at the moment. Recommend

  • Awesome1

    It is Martha Stewart, not Steward.Recommend

  • whats in the name

    @Omar: Sorry sir, beg to differ with you. I suppose by physical assets adnan meant machinery and other visible infrastructure as in case of industries. Recall for a second, just half a decade back orkut was the in thing and being on orkut was cool and look where it is today people have probably forgotten orkut. The value has gone down the doldrums. I suppose microsoft in the 1980-90, apple and google in post 2000 era were truly technological companies which could make money and create value for its share holders. Now tell me viz a viz how will face book make good money.
    Rgds
    PRecommend

  • Adnan

    @Omar: Agreed but if not a physical existence in form of your product, you do need assets backing one of the biggest IPO’s ever. Besides, Facebook has limited revenue centers; the revenues they earn from advertising etc would’ve never created that confidence in people that would motivate to buy its shares at $38. It may not be the sole reason but it was a major one. Recommend

  • Observer

    Your article is more a news report than a blog.Recommend

  • erum.shaikh

    @Awesome1: Thank you for pointing out the error in the post above. It has now been corrected.
    Kind Regards,
    The Express Tribune Blog team.

    Recommend

  • Farhan

    What is this blog. This is copied almost verbatim from NY Times reports without actually citing it. I wonder why Express Tribune even bothered to publish itRecommend

  • Omar

    @ Adnan and Whats in a name: I would still disagree regarding the physical assets. What assets does Google have, apart from data centres? I am no valuation expert, but I would imagine that for companies with non-tangible offerings, such as Facebook and Google, DCF (discounting cash flows) is the preferred valuation tool, as compared to NOA (Net operating assets) or even AOIG (Abnormal operating income growth). This being the case, its the current and mainly the expected revenue streams which are the factor when it comes to valuation. And this is where the analysts as well as the underwriters need to make sure that they carry out the proper due diligence so that they are comfortable with the revenue streams which the company is projecting.

    This poor initial analysis is the reason why majority of the M&A’s fail to deliver expected synergies – one would expect the bigger banks to ensure that it doesn’t happen but in the end it comes down to human judgement and bankers being bankers, are more motivated by the incentives associated with a successful early launch rather than the long term success!Recommend

  • AQ Moghal

    Omar / Adnan, 

    Facebook is a different business model where assets are the subscriptions and targetted advertisments to those subscriptions are the revenue streams. They dont have to have hard assets such as buildings and equipments, their asset is the code, people those who support it and their name ; and this makes it hard to keep up to..

    Sucesses in this kind of buisness are huge too, namely Microsoft, google and Amazon etc. Also too many social media failures in the area already from ICQ, AOL, myspace, yahoo profiles, orkut and many others.

     Question becomes continuation of that revenue in Fundamental analysis and potential growth which is the the basis people judge the company and invest in them specially when historical data is missing for technical analysis.Finally considering invisible arm of market ( which corrects everything) will put any service or commodity to its rightful place and folks like me believe that it will place facebook to its peer group’s EPS to growth ratio.Recommend

  • AQ Moghal

    Berg,
    I agree when SEC is involved, its a best idea to stay away till matter is resolved. I love to see more IPOs at a fair price because it is healthy for the market.

    QRecommend

  • Omar

    @AQ Moghal:

    Agreed, this is precisely my point!Recommend

  • FR

    @Farhan. It was never claimed that these facts in this blog are the brainchild of the writer. These events ‘actually’ took place and not only in the NY Times but are being talked about in every major newspaper. The idea is to discuss and generate a healthy debate about what went wrong in this IPO as some of the comments made here are very interesting.

    Well let me suggest that if you want fiction/poetry, then you are in the wrong place. Recommend

  • mrk

    The $38 price IPO price enabled Facebook to raise a significant amount of initial capital. In fact, the people who got in at the early stage were not, in most cases, the ‘small investors’. In fact, the institutional investors and other banking houses were the ones short-chained. Morgan Stanley did their job of creating adequate demand for the shares and facebook got the infusion it was seeking. Now it’s on to the markets. In IPO or financial sector in general, trade-offs continuously have to be made and facebook and Morgan Stanley made theirs. Recommend

  • Clarus

    when you wear hoodies to investors meeting this is likely to happen.

    And don’t expect that every dot com will fly like yahoo or google.Recommend

  • Farhan

    @FR: This was no blog but news story. No analysis from your own side. So you should have at least cited the sources. I am not into fiction but this is unethical to use someone else’s story without citationRecommend

  • CharlieUsman

    @Farhan: This is not a story dude.Recommend