On the Facebook IPO

Facebook Shows There's a Sucker Born Every Minute


Consider that as Facebook readied its IPO, there was a lot of shifty business: On May 15, the price was boosted to $38 from a range that bottomed at $28. The next day, the offering size swelled by 50 million shares. Then came a disclosure that insiders would sell 53% more shares, or 84 million shares, in the IPO than previously planned.

... By the time the shares went public last Thursday and started trading Friday, Facebook was close to becoming a $100 billion company with a price-to-earnings ratio of roughly 100. Those were pie-in-the-sky numbers by many measures.

They were ridiculous when you consider that Facebook reported April 23 that its growth had stalled. Revenue fell 6% in the first quarter. Profit fell 32%. There were other warnings, too.

General Motors Co. pulled its advertising from Facebook, saying it wasn't seeing a return on its investment. This wasn't the first time advertisers showed skepticism.

Facebook itself acknowledged that nearly half its advertisers considered the site experimental. In other words, as underwriters were touting the IPO and increasing its size and price, Facebook was acknowledging that it had either hit a rut or that its most robust period of growth—the kind that might support such inflated valuation models—was over.

Here's the upshot of all this: None of these factors was hidden. Facebook disclosed its worries about advertisers. It disclosed its slowing growth and all but acknowledged that it wasn't going to grow and support exponential price growth the way Google Inc. did after its IPO in 2004.
Comment: Benjamin Graham, The Intellegent Investor has an entire chapter on avoiding IPOs. It's simply not value investing. A couple of other articles with quotes: Facebook IPO Fiasco: Here’s How Small Investors Got Rolled Over
But then there are the recent revelations, which is that big institutional investors had much better information about the current condition of Facebook's business than small investors did.

This revelation may well have played into the modest stock "pop" on the first day of trading, and it may also have caused some would-be long-term institutional investors to jettison Facebook's shares, thus exacerbating the price decline.

The information that big institutions were given was estimates for Facebook's future performance, which were developed by the underwriters' research analysts. These estimates are verbally distributed in most IPOs, and the institutions use these estimates to help decide on a fair price to pay for the stock.

In Facebook's case, however, the underwriters' analysts cut their estimates midway through the roadshow, which is a highly unusual and negative event. They did this because Facebook told them that its business outlook had deteriorated--information that was not given to small investors.

As a result of this estimate cut, combined with an increase in the size and price of the deal and the number of shares sold by insiders, some institutional investors "got the willies" about the Facebook deal. Individual investors, meanwhile, were unaware that anything had changed.
Facebook Under Fire: It’s the Valuation, Stupid!
Schiff says Facebook is only the latest example of a flawed system. He blames the regulators, not because there are too few rules, but because there are way too many.

The high cost of jumping through regulatory hoops means only more mature, expensive companies can afford to go public. Up until then, the only people invested in a company were Venture Capitalists, Private Equity, and assorted well-connected, well-heeled individuals.

Those lucky few are using the IPO as a chance to cash out to the public. "By the time the average American gets a shot at all, the upside is gone," says Schiff. In the case of Facebook, the little guys may have gotten doubly hosed. During the road show, the underwriters reportedly lowered earnings estimates prior to the IPO, then only disseminated the news to select institutions and clients.

The specifics of Facebook are different, but in the larger picture Schiff says the Facebook IPO is no different than any other offering. The insiders who are selling know the company is ripe to be sold while the outsiders wager on better days.

Schiff says of the average IPO investor: "You're betting on the come but meanwhile you're paying through the nose." That's not a recipe for investing success.

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