The biggest tech IPO in history is turning into a giant metaphor of greed and hyper-optimism, as bankers and analysts struggle to figure out what went wrong and who to blame.
It wasn't bad enough for Facebook to see its stock cascade by 18% -- or seven points -- since its delayed and disappointing Friday IPO. No, the real story lurks behind the numbers: the disastrous performance of the overwhelmed stock exchange and new rumors that Facebook might have broken the law before its first minute as a public company by leaking exclusive news about its earnings to large banks, who then went ahead and told big investors to sell Facebook at the opening.
First, the glitch. Technical issues with Nasdaq's trading systems delayed the Facebook IPO by two hours. Big deal? Sure is, Nicholas Carlson reported in an exclusive interview with a hedge funder at Business Insider. Nasdaq's slip-up, and its response to traders Monday morning, could have driven the stock down by encouraging big investors to sell. Money quote: "NASDAQ knew its systems were broken before the Facebook IPO, and instead of aborting the offering and facing huge embarrassment, it went ahead. Traders then lost hundreds of millions of dollars as they tried to buy and sell Facebook stock without getting confirmation that their trades had been executed."
Even after Friday's mayhem and Monday's fog, the stock continued to fall through Tuesday. So you can't blame glitches for all of Facebook's slide ... which could always rebound by, say, tomorrow. Stocks do that.
In the run-up to Friday's IPO, Morgan Stanley's lead consumer Internet analyst cut revenue forecasts for the company. JPMorgan Chase and Goldman Sachs, two other major underwriters, followed. That takes us one step closer to solving the mystery of Facebook's falling stock price: Three huge banks changed their mind about Facebook's immediate future and told institutional investors to back off the stock around $40.
The logical follow-up question is why did all three lead underwriters take the extraordinary step -- one mutual funder: "I've never seen that before in 10 years" -- of cutting their Facebook forecast? One clue might be in Facebook's S-1, which it updated on May 9 (9 days before the IPO).
Based upon our experience in the second quarter of 2012 to date, the trend we saw in the first quarter of DAUs increasing more rapidly than the increase in number of ads delivered has continued. We believe this trend is driven in part by increased usage of Facebook on mobile devices where we have only recently begun showing an immaterial number of sponsored stories in News Feed, and in part due to certain pages having fewer ads per page as a result of product decisions. [my emphasis]
That first sentence is troublesome. Really simply, it says that users are still rising faster than ad revenue, because Facebook is still struggling to figure out how to make money off its contintent-sized audience. But is the sentence really so shocking that the banks would take the nearly unprecedented step of spooking their investors days before an IPO that they were underwriting? Perhaps not.
That's where the snitch theory comes in. Henry Blodget reports that analysts cut their estimates because Facebook told them to -- exclusively. (Not illegal, perhaps. But not cool, either.) "Put differently, the company basically pre-announced that its second quarter would fall short of analysts' estimates. But it only told the underwriter analysts ... not to smaller investors," Blodget writes. Whether it's illegal, extralegal, or just grossly unfair to average investors, we'll let the SEC decide.
The unfairness principle doesn't begin and end with the snitch, John Cassidy argues. It begins with the secondary market, where big investors gobbled up bits of Facebook for cheap and watched their shares bloom before the company went public. Since Friday, the stock has traded sideways, and then down.
The big idea here is that companies are staying private longer, which allows them to soak up up millions and for the market value to top out, leaving little on the table for average investors.* So-called "D-rounds" of late-stage stock offerings are now common for tech companies who'd like the benefits of wide-scale funding without the drawbacks of public disclosure rules. "More to the point," Cassidy says, "they allow hot companies to bid up the price of their stocks well before the investing public gets a sniff." By the time the public gets a sniff, the smart money has already cashed out.
THE LONG GAME
Keep your eye on the bigger picture. Facebook's $100 billion valuation was never about its first-hour pop or its second-quarter earnings. The valuation reflected a belief about the future -- by definition, not reflected in today's numbers -- that the biggest Internet company, as measured by attention, simply had to become the biggest Internet company, as measured by market cap.
"When you're trading at massive multiples, any hint of a slowdown in growth, or of failing to meet pretty aggressive targets, is a key sell signal," Felix Salmon writes. Too true. But, as I'm sure Felix would agree, the implicit assumption behind Facebook's $100 billion valuation was that Mark Zuckerberg, boy-king and chancellor of the social universe, could transcend the drudgery of banner ads-per-user. Facebook is deeper, wider, more media-pervasive, and life-insinuating than every social media company put together. How does that sort of company not become the next Google?! ... is the kind of rhetorical question buyers were asking themselves.
"If Facebook's profit model stays the same, this valuation doesn't make any sense," Espen Robak, the president of Pluris Valuation Advisors, told me on Friday morning, just minutes before Facebook traded publicly for the first time. In one or ten years, Facebook won't be judged by Nasdaq's glitches, or its executives' alleged snitches. It will be judged by the degree to which Zuckerberg meets the historic burden of expectations placed on his company's shoulders. Hiccups or no hiccups, this was always a bet on something not unlike magic.
*On the other hand! When LinkedIn's stock popped 100% after its IPO last year, critics blasted the banks for setting that IPO price not too high, but TOO LOW, thus screwing the entrepreneurs out of tens of millions in shares that only blossomed after LinkedIn sold them. This is a good time to reiterate that stocks are bets; analysts are notoriously hyperbolic; and whether an IPO flat-lines or goes to infinity, you can be sure that somebody is allegedly getting a raw deal.