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Facebook’s Foiled IPO: Should We Be Surprised?


The aftermath of the Facebook (NASDAQ: FB) IPO blunder left many to wonder whom to blame for the fiasco.  In less than a week’s time the status of the initial public offering of Facebook Inc. was updated to controversial.

What first appeared as a seamless (and highly profitable) opening day of trading turned chaotic when orders for some 30 million shares went unconfirmed until later in the day and some as late as two to three days afterward, according to reports.  The second act to follow in the trail of discontentment was the allegations of insider trading from lead underwriter, Morgan Stanley (NYSE: MS).  Last, and most certainly not unnoticed, was the ending of a lackluster performance of the all-too-anticipated shares of Facebook.  What fired off as an immediately hyped hot stock at $42.00 slowly crawled back down to a turtle’s pace to its original offer price of $38.00.

Nevertheless, Facebook’s opening bell race for IPO victory met trouble long before the auction began.

In an effort to explain away the technical difficulties, i.e. human error, the Nasdaq OMX Group (NASDAQ: NDAQ) CEO Bob Greifeld spoke to CNBC.  Greifeld stated that the IPO process for the OTC provider usually leaves a two-minute window open just before trading begins to allow for any adjustments or modifications to an investor’s order.  However, due to the much-anticipated volume of Facebook’s shares to be traded, instead of the two-minute gap, orders were permitted to be changed up until the last millisecond and as a result, “those modifications and cancellations proved too much for the system and responding in real time meant the execution confirmations did not get out until 1:50 p.m. Friday.”  Nasdaq also maintains that “100 percent of [the] confirmations were completed” by the before-mentioned time rather than the late Sunday or early Monday indications, and is prepared to shell out $100 million to cover all errors including any “unintended gains.”

With a capital gain of $16 billion, Facebook is now ranked as the largest US internet IPO in history and as the third largest all-time IPO, behind Visa and the Italian utility company Enel SpA, according to Renaissance Capital, an IPO research firm.  Opening day ended with 581 million shares of Facebook traded, but by the following Monday, the volume of shares traded were just over 102 million.  Adding further insult to injury, shares of Facebook have plunged 26% since its IPO.

While Nasdaq spent little-to-no time at all with explanations at a May 25 shareholders meeting by eliminating the Q&A session, Morgan Stanley has its own ‘plaining to do.  In an unheard of move from an IPO underwriter, the bank lowered their projections days before Facebook were to go public.  Reports say that the move was based on bad reviews from the May 7 New York roadshow where prospective investors were a bit miffed about not hearing more (or new) news from the company.  Investors were given the revised prospectus “in which the company expressed caution about revenue growth due to a rapid shift by users to mobile devices” — some would see this as a glaring warning sign, but visions of dollar signs instead blurred the view.  Afterwards, Morgan Stanley’s consumer internet analyst, Scott Devitt, reduced his revenue forecast for the company.  According to a CNBC story, “The people familiar with the revised Morgan Stanley projections said Devitt cut his revenue estimate for the current second quarter significantly, and also cut his full-year 2012 revenue forecast.”

Currently there is talk of the FINRA’s reviewing of both the mishandlings of Nasdaq – where the review will focus on trading on May 18 between 11:11 a.m. and 11:30 a.m. and could span as late as 2 p.m. – as well as the class action lawsuits that have been filed against Facebook Inc., Morgan Stanley, JP Morgan Chase and Goldman Sachs, the other underwriters on the deal who also reportedly reduced their estimations before the IPO launch.  According to the LA Times, the lawsuits “alleg[es] they misled most shareholders about revenue projections.”

Even before the released financial statement, it was no secret that advertising makes up the majority of Facebook’s revenue.  The amended S-1 prospectus released May 9 stated that, “For the year ended December 31, 2011, [Facebook Inc.] recorded revenue of $3,711 million, operating income of $1,756 million, and net income of $1,000 million.”  Despite these impressive numbers, however, “annual revenue grew 154% from 2009 to 2010 [down] 88% from 2010 to 2011.” Now, for the average company, $3.5B in revenue or $1.8B from operations certainly is nothing to gawk at but Facebook is not your average company.

Below are excerpts (in bold) taken from the Facebook prospectus:

Facebook user growth and engagement on mobile devices depend upon effective operation with mobile operating systems, networks, and standards that we do not control.

Facebook is dependent upon popular operating systems and thus makes no guarantee on its sustained interoperability on mobile devices.

We may not be successful in our efforts to grow and further monetize the Facebook Platform.

Facebook’s key to growth is hindered and efforts in achieving its full financial advantages may NOT be reached.

We generate a substantial majority of our revenue from advertising. The loss of advertisers, or reduction in spending by advertisers with Facebook, could seriously harm our business.

In the wake of Facebook’s revenue receding from 77% to 44% yoy, General Motors is the latest company to cancel its pay-to-play for advertising with the social networker.  The third largest advertiser in the US, behind Procter & GambleandAT&T, GM announced its plan to cut advertising the same week that Facebook went public.

Call me crazy, but, a company announcing just before it’s about to go public that the primary means of its revenue is in jeopardy of maintaining its once successful growth rate would leave me slightly hesitant to invest.  Not saying that there’s anything wrong with investors choosing to support a company they believe in — that’s why there are angel investors out there. And there’s nothing wrong in waiting in order to make a quick buck by shorting – it’s not illegal to do so. But when things don’t go according to your starry-eyed plan don’t cry foul.

As a business entity, Facebook not only revolutionized how we conduct our daily lives but how businesses attract customers.  Facebook has managed to flip the business integration-scale on its head; social interaction as a means of a business platform was an afterthought for companies, if considered at all, and of course, there’s no need to discuss what social implications ‘facebooking’ has created.  But regardless of the social impact, what makes Facebook no exception from the other IPO stories (read, Why Facebook Needs to do an ‘About-Face’), whether tech or non-tech, is that once you go public the rules of the game change.

Facebook’s mission is to “make the world more open and connected,” but under the same business model as the middleman between people and business, the company will find itself on the other side of the friend list with investors.  Facebook has captured an audience but in order to command the attention of investors, Facebook will have to drum up a whole new breed of awareness all together.

It is a misnomer to say that investors were misled … eager, yes, but betrayed, hardly.  The only thing surprising about all this is that investors turned a blind eye to what was clearly in black and white.  Facebook’s first-week stock performance was an indication that investors were betting on buildup in lieu of valuation; betting on the hope of finding the next big thing.


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