There are a number of core issues that are likely to arise during the Senate Banking Committee’s investigation. Firstly, two decisions were made very close to the IPO that clearly undermined the success of the offering. Facebook increased its offering price from $28-$35 to $34-$38 a share, raising its valuation from a range of $77 billion to $96 billion to a new range of $92 billion to $104 billion. The next misstep appears to be the increase of shares being offered, which increased by 25% to 421 million shares. The Committee will need to focus on why these dramatic changes to the structure of the offering came so close to the actual IPO. Was the interest in the offering really that great?
What is sad about the offering is that the original investors, who provide the bridge financing, can make a lot of money from an IPO. This investment firm, handling the deal, will typically enable their preferred clients (high net worth clients) to have their IPO position liquidated on the first day.
Unfortunately, the small-time investors who purchased shares in the aftermarket have now lost a substantial percentage of their investment. Even worse, some of those investors thought that they had purchased stock at a certain price but technical glitches in the NASDAQ trading system caused orders to be filled at a different price.
Morgan Stanley might suggest that strong demand for the IPO caused the company to increase the price and the number of shares being offered but there were initial indications that showed otherwise. Bloomberg reported that Facebook’s roadshow, leading up to the IPO, was drawing limited excitement from institutional investors because of its lackluster revenue forecasts. In mid-May, an AP-CNBC poll indicated that half the population felt that Facebook would be overvalued at $100 billion – a figure that increases to 62% for active investors.
Institutional investors have voiced concerns about the ineffectiveness of Facebook’s click-through banner ads. Some corporations agree and just a few days before the IPO, General Motors (GM) pulled a major advertising deal with Facebook because of the poor return on advertising investment; the company felt that Google could provide GM with significantly more effective advertising. With such a big question-mark hanging over its revenue outlook from advertising – a company so dependent on advertising – why would the valuation be raised at such short notice? When comparing the proposed valuation of Facebook ($100 billion) to other publicly-traded companies, the numbers did not seem to add up. Facebook was valued higher than Amazon – a company 17 times the size of Facebook in terms of revenue.
The Senate Banking Committee, already dealing with JP Morgan’s trading incompetence, which has resulted in losses of $2 billion and counting, must now interrogate Morgan Stanley and Facebook about their questionable methods of raising exorbitant amounts of cash for an overpriced deal. We have recently witnessed many successful Internet IPOs, like Splunk and LinkedIn, but Facebook’s IPO is reminiscent of the much-hyped Internet IPOs a decade ago, which burned many investors, even though investment firms at the time knew about the numerous imperfections of their public offerings, which most investors were oblivious to. This may be an extreme comparison but the huge losses of retail investors caused such an immense loss of confidence in the market that it took years to recover. This is why this type of fiasco must be investigated and prevented from occurring again.
Facebook will now need to use much of the capital raised from the IPO to improve the look of its own profile page to friend future investors.
Hayes chairs the computer information systems program at Pace University’s Seidenberg School of Computer Science and Information Systems in New York. He is also an associate member of Pace University’s Seidenberg CyberSecurity Institute. A former investment banker, Hayes began his career in the financial services industry with Cantor Fitzgerald at the World Trade Center.