The Facebook's IPO and the Chronicle of a Death Foretold

May 28, 2012
Facebook's highly anticipated IPO turns into a major disappointment, as shareholders suffer losses and allegations of insider trading surface.
The biggest and most anticipated IPO in the history of the tech industry finally happened and it wasn't just disappointing. Despite the title closing its first trading day on NASDAQ with unchanged value, shareholders who rushed to buy on Friday's release would find out they were happy and didn't know it when the title closed the following week with a reduction of nearly $6 from the initial $38. They were even less pleased when they found out that the banks responsible for offering Facebook's shares to the market had inside information about the social titan's second quarter earnings and these banks decided to buy fewer shares for themselves, but kept the amount intended for customers. Problems with the integrity of the share offering aside (Morgan Stanley alone would have made nearly half a billion dollars with the drop in the value of Facebook's paper), the realization of the company's hyperinflation was clear for many weeks. But not everyone wanted to see it.
Earlier this month, the Wall Street Journal did a very accurate piece about a rumor running in the market about Facebook's announced launch value of about $104 billion. The article showed how the site got a very small revenue per user per day and how the value continues to fall, something offset by the astronomical number of views the network generates. More than that, it suggested that to have the valuation of a hundred billion dollars, it would need to have a revenue growth of 41% per year for five years - a growth that fell in the last quarter of 2011, rose in the first quarter of this year and, as far as everything indicates, will not perform as expected this quarter. To encourage investors, Mark Zuckerberg himself went on a roadshow for investors to show how the machine that makes $3 billion a year would have the necessary growth to reach the announced capitalization value.
Today, in the second week after the initial public offering, Facebook's titles continue to fall, hitting $31.91 on Monday morning. The distortion becomes more shocking when numbers are put into the equation. A consulting firm affiliated with Reuters made a conservative projection for FB's revenue growth of about 10% per year, which would estimate the fair value of the company's paper at the IPO for $9.59, approximately 70% less than the value at which they were offered to investors. Unsurprisingly, numerous investors have already filed lawsuits against Facebook and the banks involved. Yes, they were vigorously fleeced while customers, or muppets, a nickname given to customers at Goldman Sachs, according to a former analyst. Visiting forums with subject matter experts, the impression is clear that there was bad faith, in an episode that very much reminded of the movie Margin Call, a film that portrays the perversity of Wall Street.
The news following the IPO is not encouraging. As I wrote about two weeks ago, Facebook's potential for revenue growth strongly depends on legislation related to user privacy and this promises to be a rocky terrain, with Google itself having difficulty convincing the European Union that it does not abuse its position to monopolize the market and also with the entry into force of the new European law on cookies. In addition, Facebook needs such significant improvements in the field of mobile access applications (already responsible for 20% of traffic in the US) that it made a change in the text of its initial share offering exempting itself from achieving exceptional results in this sector.
Then comes the question: how was it possible, then, that the overwhelming majority of the tech media was so enthusiastic about Facebook's entry into the Stock Exchange? That the social network is a spectacular business, ok (it is not the case to say that it is a great fallacy, as some bloggers did), because it is a company with billion-dollar revenues, but betting on a market value of $100 billion was only interesting for Zuckerberg, the banks and the other majority partners. General investors really played the role of muppets.
The episode is already being pointed out as the beginning of the end of the second tech bubble. It may seem exaggerated, but the fact is that smaller investors will think more before putting money again in startups with zillion valuations (think Pinterest worth $1 billion less than a year after launch). The technology specialized media becomes less and less reliable, given the lack of restrictions it put on the IPO. Yes, Facebook has giant growth potentials, such as entering the media production market, or making acquisitions like Instagram or the likely purchase of the Opera browser and it is not unfair to accuse Facebook of having, alone, induced customers to tear money buying overpriced shares. As the character Will Emerson (Paul Bettany) says in Margin Call, the financial merry-go-round has brokers' fingers doing things for investors to profit. "People want to live in houses and cars they can't afford," says Emerson. That's why they end up believing in the siren's song. If they believe, they have to have their share of the blame.

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