Understanding the drama of the Facebook IPO

Why does everyone think that the Facebook IPO was a disaster? Christian Gladwell, from Human Digital puts paid to the nay-sayers.

by Christian Gladwell
Last Updated: 04 Oct 2012

It’s been a hell of a week for Facebook's CEO, Mark Zuckerberg. On Friday he rang the opening bell on the NASDAQ, crystalized his personal wealth at $19bn, saw $1.8bn wiped off that by the close. Then he got married. As he begins his honeymoon Facebook shares are down again, closing 10.99% negative on their opening valuation. It seems commentators are more bullish towards Zuckerberg’s marriage than his corporation’s future. Why?

The NASDAQ closed 2.5% up on the day (Monday), with tech stocks Amazon and Apple rising 2% and 6% respectively. Zynga (whose business depends on Facebook’s platform to a large degree) and Groupon bounced into positive territory recovering earlier losses. So it seems that FACEBOOK bucked the market trend, stimulating speculation that its future is in jeopardy. You can’t make that call for one very good reason:

Facebook’s performance at IPO had nothing to do with its business model. In fact it had nothing to do with Facebook.  

When LinkedIn offered in 2011 it closed its first day up 109%. In a global equity market hungry for good news, it looked like social networking companies would buoy the market. Yelp, Zynga and Groupon followed, each delivering worsening performances in sequence. Thus when Facebook finally came to shore its moorings – she launched into rough waters. If you really want to understand the last couple of days, however, you have to mine the data.

LinkedIn issued heavily into the retail market (individuals rather than institutions), issued less than 20% the number of actual shares that Facebook did, and leveraged a less aggressive pricing structure than Facebook. Morgan Stanley, Facebook’s broker, originally published a price range of $30-$34; then, as the proposed IPO dragged on in the press, hiked it to $34 - $38. The volume of shares to be issued increased significantly to 168m (LinkedIn issued in the low 20’s). 

In order to support a deal of this size the support of the institutional sector was required. Long-term investors have very little margin for tolerance in their pricing models therefore Facebook was expensive for them at $30-$34 a share, let alone $38. 

Institutional money is very cautious. Furthermore, stories are surfacing from Morgan Stanley that NASDAQ systems could not cope with the volume of trading, specifically the confirmation of whether trades were actually completing. Given the profile of the deal, and amid such a confused landscape, one can understand why Morgan Stanley felt the need to step in and support the stock itself. The brokers’ version of falling on your sword.

In an academic sense markets can be primeval things comprising two key forces: Supply and Demand. Underwriters model demand. This time they got it wrong big time. By grossly overestimating demand, they lulled the sales force into a false sense of security, which meant they concentrated on easier targets, namely the retail sector. This meant the sales pitch had more to do with the glamour of The Social Network movie than anything else. This fed the hyperbole around the deal, which made the institutional money less inclined to invest.

Zuckerberg was right to go on honeymoon the day after his IPO: to think that his company’s current share price is in anyway a reflection of the strength of his business model is to miss the point.

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