Repercussions of the Facebook IPO Flop
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Much is being made of the IPO of Facebook (NASDAQ: FB) and in particular the roles of lead underwriter Morgan Stanley (NYSE: MS), and major secondary underwriters Goldman Sachs (NYSE: GS), and JPMorgan Chase (NYSE: JPM). Let's take a look at the facts as we know them as of this time, and the probable repercussions to these companies going forward.
If one posits that one critical aspect of any IPO is that all buyers are to be treated fairly, it is hard to imagine a bigger fiasco than this offering. The day public trading began, some sort of computer snafu at NASDAQ caused many trades to go unfilled, and others to only be filled at a price the buyers had not anticipated.
Facebook is understandably concerned with its future with NASDAQ, if the first week is to be any guide for foretelling the future. Facebook is considering changing its listing to the NYSE. I cannot remember the last, large tech stock to choose the NYSE in the last 25 years.
I never have been much of a fan of Facebook as an application or as an investment. So I am not going to do any sort of in depth look at it. Suffice it to say that just because it has a billion users does not guarantee any level of profitability. When the prospectus for the IPO was first prepared, it was said that Facebook itself would sell 180 million shares of stock, and that then current shareholders, including CEO Zuckerberg would sell a little less than that amount. However, as the IPO date neared, then current holders, not including Zuckerberg, decided to unload 100 million additional shares, summing to an unheard of 57% of the total IPO issuance coming not from the company, but from then current shareholders. Did the shareholders know that the $38 price of the offering was a fiction, puffed up by zest and zeal not in any way supported by numbers? Investigations may well tell that tale.
Morgan Stanley is an investment banker, not a retail bank. I expect it to take more risks, and achieve both greater losses and greater reward from those risks, than traditional retail and commercial banks. Being the lead underwriter for what was history's second largest IPO was a large; make that huge, feather in its cap. If the price were $34 per share, though, it would only have been the third largest IPO. Did that lead to Morgan Stanley's maintenance of the $38 per share IPO price, stem from the desire to make the feather as large as possible? Investigations may well tell the tale.
Hearsay tells us that Mark Zuckerberg wanted desperately to have Facebook's market capitalization be over $100 billion, so much so that he laughed off bankers who tried to convince him otherwise. Was Mr. Zuckerberg's acknowledged pride and even arrogance the reason why this was one of the least successful major IPOs in memory? Investigations may well tell the tale.
And all those investors; did we really think Facebook was a $100 billion company? I don't even see it as an $80 billion company. Its earnings are not well defined, and its best growth days are most assuredly behind it. It is currently trading at 76 times earnings, making it one of the frothiest big capitalization stocks around. It has limited assets, and while users of Facebook will undoubtedly continue to grow, that does not necessarily equate to revenues growing.
Morgan Stanley was given a 38% share of the IPO, JPMorgan a 20% share, and Goldman Sachs a 15% share. The balance was divided among a dozen or so firms, including Bank of America with 6.5% and Citigroup with 2.25%. After opening at $38, Facebook briefly touched $41 per share before trending down over the next few days to the low thirties.
What is important to realize, is that in the absence of a provable conspiracy among and between Facebook, the underwriters, and third party analysts, it is hard to see how anyone other than the lead underwriter, Morgan Stanley, did anything illegal or actionable. Facebook's prospectus fully disclosed important risks, including its slowing growth in advertising revenues. And despite analysts downgrading their earnings and revenue estimates, they were forbidden from publishing their estimates to individuals who were not their clients. I do not expect any of the underwriters, other than Morgan Stanley, to feel any significant administrative or legal hurdles. Morgan Stanley was on one hand, among the very analysts who were downgrading Facebook a few days ahead of the IPO, while on the other hand leading the cheerleading as lead underwriter. That sort of conflict of interest is absolutely absurd, and Morgan Stanley more than deserves the damage to its reputation, and its balance sheet, that the Facebook offering will ultimately entail.
Within the past few years Morgan Stanley had more or less successfully lead the underwriting for other new age technology companies such as LinkedIn, Zynga, Pandora, and others. And it is possibly still the case that Facebook will become the next Amazon or Apple. But this is a big black eye on the investment community and Morgan Stanley in particular. It is also a reminder of my opinion that no commercial bank had any business being involved with this or any other IPO, and I still wish I heard more chatter about reinstating the Glass Steagall type regulation or legislation that would segregate commercial banks from investment banks.
I would not invest in Morgan Stanley until this episode is behind it. JPMorgan, of course, has other, bigger issues, and I would certainly avoid that company as well. Goldman Sachs, on the other hand, has already lost some 25% of its value since late March, and with its low 5 year PEG of 0.66 might appeal to risk seeking individuals who can handle the inherent cycles and volatility of the investment banking industry.
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