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The Successful Facebook IPO
The hype surrounding the initial public offering (IPO) of dominant social network Facebook (FB) was far more intense than the norm. Many IPOs come to market and barely anyone notices. It would have been nearly impossible for investors, let alone the average American, not to notice that Facebook was selling stock to the public.
Such hype often surrounds technology companies, but even there, Facebook's IPO was a bigger news item than most. The rumors of an offering began well before the IPO was announced and the story only seemed to get larger as Facebook's dominance of the social network space increased. When rival network LinkedIn (LNKD) went public its shares closed over $10 higher on the first day and held at least a portion of that gain for about two weeks before selling pressure pushed prices lower. This may have caused the noise over a Facebook IPO to get even louder.
Leading up to the offering there was speculation that Facebook's shares would jump as high as the shares of LinkedIn, or more, with comparisons to such giants as Google (GOOG) and Amazon.com (AMZN). As the big day drew near, however, concerns began to surface about too many shares being sold and insiders trying to cash out. This led some to foresee weakening financial results and a middling stock performance, at best.
In fact, prior to the IPO, Value Line’s Simon Shoucair noted that “…recent filings indicate that Facebook’s revenue growth is decelerating and its year-to-year earnings actually fell in the recently ended March period.” That was not a glowing summation, but also not the only warning he provided, as he continued, “At present, ‘click-through-rates’ on Facebook have been quoted well below the industry average and the revenue it generates from each of its users is only about $5 a year. Hence, many advertisers remain unconvinced that money spent on advertising with Facebook is likely to lead to a sale.” Shoucair even noted General Motors’ (GM) recent decision to dissolve its Facebook advertising budget. When General Motors, one of the top five advertisers in the nation, opted to walk away, it seemed there were clear warning signs for anyone looking, but hype and euphoria can often blind investors. In fact, the market was even abuzz about the sheer number of shares that were being sold, which many speculated would result in weak share price performance.
In the end, the concerns proved true, as the shares sold to the public seemingly swamped demand. While they edged slightly higher on their first day of trading, they quickly fell well below their $38 IPO price. In the days since, investors, regulators, and politicians have collectively thrown a yellow flag and called foul. The question seems to be, “How could such a hotly anticipated IPO not 'pop'?” After all, an initial share price advance has become an almost expected phenomenon, particularly in the technology space.
However, it is important to remember the point of an IPO. Companies come to public markets to raise money. The reasons for raising money vary from supporting a business' growth to insiders cashing out, among others. But, at the end of the day, the point is to raise as much money as possible. Facebook managed to raise about $16 billion, the high end of its desired range. By this measure, the Facebook IPO was a smashing success.
In fact, an IPO launch in which a company brings shares to market only to see those shares soar after trading has commenced could legitimately be viewed as a bigger problem. In this situation, the investment banks clearly misjudged the demand for the shares and, in the end, that misjudgment cost the company money. It also begs the question of how the shares were distributed, since the “pop” could conceivably create instant, and perhaps undeserved, wealth. Investors, though, seem to like the “get rich quick” idea of buying a hot IPO and seeing their new shares rocket higher. While this is an understandable sentiment, the risks involved are greater than most realize—and the Facebook IPO proves that point.
It is clearly less desirable to buy shares in a big IPO only to see the price languish, or worse, drop. A flat opening, though, indicates that demand and price are at an equilibrium point. A material fall suggests that the investment banks overestimated demand, but, from the issuing company's point of view, it still raised the most money possible—perhaps more than should have been expected, but, either way, the company ended up a winner—even if the investor might not have.
Facebook's IPO not living up to the market's expectations for technology company launches has resulted in a chorus of anger and concern. Investors are crying foul; regulators are looking into the matter; and politicians are weighing in. There were problems with this IPO, including at the exchange. Moreover, if investigators search hard enough, they will probably find someone who said something to somebody that they shouldn’t have. That said, as noted above, the bad news was out there for all to see—if they wanted to see it.
Not living up to the preconceived hype seems to be the big offense here. And now that things have soured, it looks like people are trying to find someone to blame other than themselves. For Facebook, though, this initial public offering would be hard to call a failure, financially speaking.
It’s also important to note that the long-term success of a company isn't predicted by the initial trading of its shares. Living up to the hype about the company's glowing prospects, as opposed to the prospects for a quick IPO bounce, will be the real challenge. Of course, legal issues resulting from the IPO could still prove to be a material distraction along the way.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.