SKARBECK: Facebook flop casts doubt on remarkable valuations

June 2, 2012

Ken Skarbeck InvestingAfter a year of escalating hype, Facebook’s May 18 initial public offering failed to come anywhere near Wall Street’s glorified expectations. Most observers, me included, thought we’d see the ritualistic price pop that accompanies hot stock offerings, with the only point of debate being the degree of the increase.

Instead, the social media company’s stock spent its first day struggling to trade above its $38-per-share offer price and $100 billion valuation. In the days that have followed, the stock has dropped more than 25 percent, to as low as $28.

The fallout from this dud IPO has been swift, with plenty of finger-pointing.

Decisions made by Facebook and underwriter Morgan Stanley to increase both the offering price (from $35 to $38) and the number of shares offered (to more than 400 million) certainly contributed to the market’s poor reception. And sellers increased the amount they were cashing out to an unusually high 57 percent of the offering.

The NASDAQ OMX market, the exchange Facebook chose to list its shares, experienced a number of glitches, causing trading errors and delays in trade confirmations.

Morgan Stanley, as lead underwriter, botched the effort to support the share price in initial trading. Underwriters typically use various methods to support post-IPO trading, including using some of their own capital to buy shares to support the stock.

Perhaps more damaging was the discovery that Morgan Stanley’s own analysts engaged in “selective disclosure” to preferred clients before the IPO, alerting them that they were cutting their revenue and earnings forecasts for Facebook.

Irrespective of the IPO morass, the fact that 8-year-old Facebook commands a $60 billion market value today is remarkable. While public shareholders lick their wounds, the big money was made by the early-stage venture capitalists and other investors who acquired shares over the years in the private market. A fairly active private market in Facebook shares allowed certain investors to buy and sell the stock and delayed the need for an IPO. So by the time it occurred, much of the irrational exuberance that accompanies a hot offering was already built into Facebook’s valuation.

The market rightfully choked on Facebook’s nosebleed valuation set by the greedy promoters. One benefit from this debacle is that it would seem to have spared investors from a potential parade of overpriced, bubble-forming social media IPOs.

The financial media can now delete from their interview schedules all those 20-something Silicon Valley entrepreneurs, who do a fine job brainstorming new businesses but lack any ability to attach a rational value to them. Perhaps the Facebook flop is a sign investors won’t be as quick to drink the Kool-Aid.

Amid all the pomp and circumstance surrounding this IPO, one has to wonder how many investors really took the time to ponder what they were doing when buying a share of Facebook. Whether buying one share or 1 million shares, did they try to figure out what an investor should pay for a business with $1 billion in earnings that, while growing fast, has shown some signs of slowing?

Is it really worth $100 billion or is the current value of $60 billion right? Either way, it is still far too pricey for my taste.•


Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebaran.com.


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