Who’s Winning and Who’s Losing from Facebook’s Botched IPO
By Adam J. Crawford, Casey ResearchÂ
In less than a week’s time, the Facebook IPO has gone from the most-hyped technology event since Google went public into “blame-storming” mode. Details concerning the stock’s sudden drop, the market’s inability to process orders, and the (mis)behavior of insiders are starting to emerge. And it doesn’t look good.
The Scandal
When any stock drops as much out of the gate as Facebook has – down as much as 25% peak to trough in the days since the public premier of the stock – people start asking big questions… even more so when that stock carries a $50-billion-plus market cap, meaning the loss triggered billions in paper losses. Add on the fact that the Nasdaq market computers crumbled under the activity, and the scrutiny is intense.
What’s been uncovered so far is painting a picture of poorly managed expectations and questionable ethics. The key event behind the drop appears to be a massive shift in expectations from institutional investors at the last minute.
Evidently, a Facebook executive – at this stage we can only guess who – alerted analysts that previously issued revenue estimates were a bit optimistic. Shortly thereafter, the analysts took the unusual step of slashing revenue estimates during Facebook’s IPO roadshow. The information was then relayed to a select few potential institutional buyers. The financial community calls this “selective disclosure.” I call it BS.
To make matters worse, Morgan Stanley (the lead underwriter and one of a select group of banks privy to the lower estimates) actually raised the offering price and issued more shares publicly, despite cutting the revenue estimate behind closed doors. Initially, Facebook shares surged due in large part to robust retail demand. However, once gravity took hold, Morgan Stanley chose to step in and provide some temporary support at the original offering price of $38 a share. The bank stepped into the market and bought millions of shares back from the public. It was able to do so without risking much capital thanks to the massive “greenshoe” allotment it took at the IPO – a gift of nonexistent shares the bank can sell risk free to the public if they have the demand. Stock goes up, and Morgan Stanley can force Facebook to cough up more shares, diluting investors and pocketing the profit. Stock goes down, and Morgan Stanley can buy them back below the IPO price, wiping out the excess volume and pocketing the price difference. Not bad deal, eh? Thankfully, most banks do exercise some level of ethical caution with those overallotment shares and use the process to instead stabilize the market, as happened with the over 60 million shares Morgan Stanley bought back from investors.
Consequently, Facebook shares stabilized and ended the trading day flat.
Facebook’s humdrum opening-day performance was a minor disappointment for speculative investors hoping to flip shares for a quick profit. The minor disappointment soon morphed into a major disappointment for all shareholders, once rumors spread about the behind-the-scene shenanigans mentioned above. One look at the stock chart will show you the unpleasant Monday-morning surprise shareholders arose to the next trading day.
(Click on image to enlarge)
Facebook shares have since settled near $32 a share but remain exceedingly temperamental. A skilled trader could probably make a few bucks off this volatility (but a day trader I am not, so I can’t help you there). As far as Facebook’s long-term potential goes, I can offer a quick analysis.
The Future Outlook
Despite our decrying of the trading practices of Wall-Street banks, when dealing with a company of this size and whose relationships with the banks run this deep, one of the best sources of data on the company will remain the consensus opinion of their research arms. Below are their earnings-per-share growth estimates for the next three years:
As you can see, earnings growth is projected to slow to 21% by 2014. That’s exactly the growth rate Google – a company with nearly 10 times the annual revenue of Facebook – is estimating for 2012. And for that kind of projected growth, the market places a value of 18.5 earnings on Google’s stock. Let’s be generous and award Facebook a 25 multiple for 21% growth. A little back-of-the-envelope math suggests that would place its value at about $20/share ($.80 EPS x 25) three years from now!
