The Future of FB: Bullish or Bearish?

Screen Shot 2012-05-24 at 3.08.42 PM
Screen Shot 2012-05-24 at 3.08.42 PM

Unless you’re hiding under a rock, there’s a good chance you heard about Facebook’s initial public offering on Friday, May 18th. Eight years in the making, Mark Zuckerberg’s social network is officially in the big leagues. After months of analysis, a price of $38/share and a valuation of $104 Billion were decided. Clad in one of his infamous hoodies, Zuckerberg rang the opening bell for the Nasdaq and the anticlimactic day was off to a start!  What was to follow would be a sad few days for investors in short call positions, and main underwriter (and stabilization agent) Morgan Stanley, as the stock plummeted 12% on its second day of trading.

The initial day of trading was quite stressful as Morgan Stanley spent the majority of its emergency reserves to create a floor of $38 for the stock. This emergency reserve is typical of all IPO’s and can be used to either sell shares if demand is high, or buy shares if the price starts to slip - creating the price floor. This stabilization was required of Morgan Stanley in their terms as an underwriter to keep the price above $38/share. Don’t feel too bad for MS though, this enabled them to acquire the highest saturation of FB stock, virtually risk free. If it were not in their best interest, their support would immediately be revoked.

So what went wrong, you ask? Fundamentally - nothing. Although there are rumors that analyst projections were ignored by Facebook (hence ensuing lawsuits), I don’t believe there is anything in particular that specifically went wrong or could have been avoided (besides glitches in Nasdaq systems that delayed trades by 30 minutes). IPO’s can be incredibly volatile. Considering that Facebook is the highest valued IPO in tech history, some investors were anticipating a ‘pop’ of sorts. This kind of ‘pop’ can only be achieved if the stock is undervalued, and an influx of demand will cause the price to sky rocket. If the price is accurately forecasted, no ‘pop’ will ever occur. In other words, if underwriters do their job correctly, the IPO got the best deal it possibly could. Markets are efficient. If you’re waiting for your big chance to make your millions on an arbitrage opportunity, don't hold your breath. Although some investment bankers may disagree, these instances are the exception - not the rule. Facebook has run into trouble with people that don’t realize the volatility of the market. To even mildly judge Facebook’s health as an investment, it takes months and years - not hours and days. Although past earnings do not predict future returns, it’s incredibly hard to judge an IPO right out of the gates.

IPO’s can be a startup killer (i.e Groupon). Where in the past their business model flourished, there are some inevitable changes that must be made once a company is no longer private. The ultimate goal of any publicly-held company (by law) must be to maximize shareholder value. The customer’s best interest must be replaced with shareholder’s interest. It’s possible that these can be complementary, but in the case that they aren’t, it can be a serious factor in the health and longevity of a corporation. Facebook got some initial criticisms regarding this, but are also all too aware that these changes are not optional. Zuckerberg had the following to say about the implications of Facebook becoming a publicly owned company:

“We don’t wake up in the morning with the primary goal of making money, but we understand that the best way to achieve our mission is to build a strong and valuable company. This is how we think about our IPO as well. We’re going public for our employees and our investors. We made a commitment to them when we gave them equity that we’d work hard to make it worth a lot and make it liquid, and this IPO is fulfilling our commitment. As we become a public company, we’re making a similar commitment to our new investors and we will work just as hard to fulfill it.”

What it ultimately comes down to is a waiting game. Only time will tell whether Facebook was (or is) a good investment. Constant innovation and solid financials are going to be the key determining factors as to the success of Facebook’s IPO. Facebook could certainly increase the value of their stock by finding a way to better optimize their advertising business model. In fact, it would be incredibly valuable for them to look to Google in this area. It has been said that Google has a 100x higher value of click-throughs in their ads than Facebook because their users are there with the intention of buying something - not the case for Facebook.

In this day and age, especially in the technology sector, everyone is looking for instant gratification. This is evident in the price drop of Facebook's stock, as investors sold almost immediately when the price did not grow as rapidly as some had hoped. What does this mean for tech IPOs in the future? It's hard to know, but hopefully a success story in Facebook will show future investors the error of their ways.