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Facebook IPO Was a Success and Wall Street Got What it Deserved

May 31, 2012 | About:
Being politically correct has never been my strongest quality; therefore I’ll say this: I don’t feel sorry for Facebook (FB)’s new shareholders. Despite NASDAQ technical glitches and analysts sharing changes in estimates for the near quarter only with big clients, the Facebook initial public offering (IPO) was a success.

Yes, a success.

See, the IPO market in the US is rigged. It is used by the big brokerage firms to butter up their best clients -- the ones that bring them the most business -- and not [necessarily] to benefit the shareholders of the IPO company. This is Wall Street at its worst. The underwriters are supposed to represent the interests of their client, the IPO company (in fact they get paid handsomely to do so) but there is a conflict between the one-time fee they receive from the IPO company (plus, maybe, the fees they receive if the post-IPO company decides to seek their advice in future M&A activity) and the very predictable trading commissions that are trickling in every single day from their large brokerage clients. To rig the IPO for the benefit of the brokerage clients, underwriters create an imbalance between supply and demand by keeping the offering price significantly below the level where supply/demand indicates it will open. That way, the best clients get to own the stock for a few minutes or maybe a few hours, the stock jumps 20 to 50 percent, and they flip it for an astronomical annualized internal rate of return (IRR).

I know it will be hard for me to elicit any pity for the company’s founders -- the newly minted billionaires and multimillionaires -- but it required risk taking, a lot of creativity, endless willpower, and sleepless nights to build a company out of nothing. Private-equity and angel investors will get even less sympathy from you, but they took a risk and bet on something nascent. We see and envy their successes; but we don’t see their failure, which happen a lot more often than we think. The speculators that add little economic value make these insane (usually almost guaranteed) returns at the expense of insiders.

Facebook’s IPO was a success because the insiders received full and fair value for their shares at the time of the IPO, though the stock did not go up 50 percent or double in a few hours after it went public. This is not a comment on Facebook’s valuation -- I’ve addressed it before, and my view has not changed -- but has to do with simple supply and demand for the stock at the time of the IPO. The Facebook CFO who is blamed for poor performance of the stock since the IPO is a hero and should be praised for forcing underwriters to raise the number of shares issued and increase the opening price.

I also don’t feel bad for speculators who were loading up on shares, hoping a bigger fool would come along and buy them at a higher price: sometimes when you look for a bigger fool you end up looking in the mirror. Investors who bought Facebook at IPO, the ones who believed that Facebook shares were undervalued for fundamental reasons, should now celebrate the stock’s lower price. If they loved it at $40, they should be ecstatic at being able to buy it for $29. Absolutely no news came out over the last few days, including changed estimates for this year’s revenue and earnings, that should have changed the fundamental value of Facebook. Investors were not buying Facebook on this year’s 100x earnings or 25x revenues -- if they did, they were fools; they were buying because they believe Facebook will be an unstoppable force that will make a lot (A LOT) more money in the future.

I get a kick out of media ridiculing Mark Zuckerberg for the ‘audacity’ of eating burgers with his wife in Paris on their honeymoon, while his company is ‘in crisis.’ In Zuckerberg’s eyes nothing has changed, and he is right. He did not want to bring the company public, because he didn’t want the short-termism of Wall Street and the media impact on the way he runs the business. To Mark’s credit, he is a controlling shareholder and doesn’t care what earnings Facebook will deliver next quarter -- he is building a lasting franchise.

The day of the Facebook IPO was the day of justice, the day when the Wall Street got (deservedly) screwed and a company was brought public at a fair price.

About the author:

Vitaliy Katsenelson

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email or read his articles click here.
Investment Management Associates Inc. is a value investing firm based in Denver, Colorado. Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy’s book Active Value Investing (Wiley, 2007).


Visit Vitaliy Katsenelson's Website


Rating: 3.5/5 (11 votes)

Comments

ilsadore
Ilsadore - 2 years ago
Hi, I think its incorrect to assert that you know Zuckerberg is building a lasting franchise, or that he refused to go public for so many years in order to avoid 'media or Wall Street impact'. It's possible his major and lasting problem is finding a way to make a Facebook a paying, big business, instead of just a big fad. We've all heard for years that he's got a problem trying to monetize the business. The pressure he is under now is not media or street impact; the problem is pressure to put up revenue and profit numbers that show it can grow into its valuation. Maybe he just hasn't wanted to step into the deep end of the pool where he might have to economically aggravate his users in order not to drown.

In any case, it was foolish to say what you did with such certainty.
kfh227
Kfh227 premium member - 2 years ago
I feel very bad about this IPO.

What happened:

Insiders got shares

Insiders dumped shares the first day

Who bought?

Mutual Funds?

Who owns those?

People via retirement accounts that are oblivious to the fact that they are getting screwed.

Not cut and dried like I stated but it is in fact what happened to an extent.
bobperryh
Bobperryh - 2 years ago
The problem I see with this deal is that many of Facebook's new shareholders are customers, users of facebook. Rather than benefiting from the pop that new issue pros usually count on, individuals lost money. Yes, in a way this is how ipo's really should work, but I don't know that facebook gains by pissing of many of its own users.

They brought a small percentage public. They could easily have thrown everyone a bone and everyone would have loved facebook. Instead they generated horrible ill will.

They made a big deal about opening this up to more individual investors and then went and priced it too high. They could have stated they were opening it up to the etrade's and ameritrades rather than their usual best customers because they wanted to price it as high as possible and plug everyone at the top.

The more I write the more I think everything about this deal really stinks.

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