Like Jon Weil, I’ve got little sympathy for the folks who speculated on Facebook at $38, thinking it would double in price on day one but who instead three months later are sitting on 50 percent losses.
Buying a stock priced at 100 times earnings in a company whose revenue growth is slowing sharply, whose costs are growing even more dramatically, whose user base can’t really get much bigger, and whose peers’ shares have plunged since their own recent IPOs, is almost always a bad idea.
Weil was responding to Andrew Ross Sorkin’s New York Times column earlier this week that tried to shift as much blame as possible from his banker sources onto Facebook itself, in the person of its chief financial officer, David Ebersman:
It is David Ebersman’s fault. There is just no way around it.
If you don’t know the backstory, here’s a quick rundown: In May, Facebook IPO’d at $38 a share, which valued the company at $104 billion. Nasdaq messed up the first day of trading. There was no first-day “pop” as big investors bailed on the stock after getting inside information from Facebook in the days before the IPO. Facebook’s growth outlook has continued to slow since the IPO, and its shares have plummeted 53 percent from the launch.
The trouble with Sorkin’s analysis, as lots of folks have pointed out, is that Ebersman was selling his product for what he could get for it. When Wall Street and Wall Street journalists are criticizing somebody for doing that, you know something’s up.
After all, pre-IPO, Facebook shares were trading on private markets at levels that valued the company at $103 billion, a hair below its $104 billion IPO valuation.
Yet Sorkin says:
Mr. Ebersman appears to have badly misjudged the demand for Facebook’s I.P.O. He was aided by errant advice from a cadre of banking advisers, who all had an incentive to sell as many shares as possible at the highest price possible.
But, far more than the CFO, it was the bankers’ job to judge the demand for shares, which is why it’s bizarre that Sorkin is fingering Ebersman here while reducing bankers to secondary responsibility. Here’s how The Wall Street Journal reported what happened in May (emphasis mine):
Less than three days before Facebook Inc.’s initial public offering, Chief Financial Officer David Ebersman decided to boost the number of shares the company would offer investors by 25%, said people familiar with the planning. His main adviser at lead underwriter Morgan Stanley assured him there was plenty of demand, they said…
Mr. Ebersman and his bankers saw eye-to-eye on key decisions, these people said. Michael Grimes, the co-head of global technology banking at Morgan Stanley, was his main confidant, they added.
“This IPO was an Ebersman and Grimes show,” said one of the people familiar with the matter. “They were joined at the hip.”
Sorkin doesn’t even mention Grimes, subject of a source-greasing DealBook profile in the days before the IPO. Actually, nobody at the NYT has mentioned Grimes’s name at all since that beat sweetener even as The Wall Street Journal, forthrightly, has written three negative stories about his key role in the IPO bust with headlines like “Facebook Flop Puts Investment Banker on the Spot” and “Morgan Stanley Was ‘Driver’ on Facebook’s Wild IPO Ride.”
The WSJ reported that Grimes insisted on being the “single driver” of the IPO to the exclusion of other banks and that he told Ebersman the IPO was “dramatically oversubscribed,” which led Facebook to sell more shares.
But this Journal paragraph is best at showing why Sorkin’s column is so upside down:
Pricing an IPO is as much art as science. A lead underwriter like Morgan Stanley must balance the interests of the stock issuer and investors. Companies like Facebook want a high offering price so they can raise more money. Investors taking a risk on a new stock want a price low enough that it is likely to pop when trading begins.
That gets the interests and motivations about right.
This all not to say that Facebook and Ebersman are in the clear here. But, oddly, Sorkin effectively absolves them of their worst actions: Sharing critical details of Facebook’s slowing finances with Wall Street analysts but withholding them from retail investors. Sorkin says:
The disclosures in the company’s I.P.O. prospectus — which were Mr. Ebersman’s responsibility — were, for the most part, pretty transparent, giving investors a good sense of the business, despite all the hype.
Problem is, they were extra transparent if you were a Wall Street analyst or one of their big clients. I don’t usually disagree much with Weil, but he’s sort of on the same page here, writing that “In spite of the shareholder lawsuits filed against Facebook, I have seen no indication that the company’s executives lied to the public about its performance or prospects.”
I don’t think Facebook lied per se. But it told a select group of analysts and investors about material revenue declines while giving everyone else a much blurrier picture.
Facebook’s defense is that it amended its S-1 on May 9 to say that increased mobile usage was hurting its results. But that language is barely different than what the prospectus had said all along, as VentureBeat noted in an excellent piece back in May.
The difference is that Facebook told Wall Street in the nine days before its listing that its revenue growth was being hurt by mobile (some 5 to 7 percent), while it told everyone else that it could be hurt by mobile. Whether that’s illegal, well, I’m not a judge. But it’s sure not right, and it’s at least questionable enough to have the company and/or its bankers facing a class-action lawsuit from shareholders, a preliminary inquiry from the SEC and FINRA, congressional questions, and at least one subpoena from Massachusetts.
This quote from a Reuters story in May shows how serious a matter this could be:
“If Facebook told analysts to materially lower their forecasts, it should have told the entire market,” said Antony Page, a professor at the Indiana University Robert H. McKinney School of Law. “We need to know what exactly was said to the analysts, and determine how different Facebook’s public story was from its private story.”
Beyond all this, though, Sorkin ultimately ignores the big story: That Facebook and its bankers knew that its growth was slowing and that investors were dramatically overvaluing the company, and cashed in on the bubble before everybody else caught on. This was a company that immaculately timed the peak of a mania.
That Facebook shares have collapsed since then is because the expectations that supported their sky-high valuation have come back down to earth, as they should. Everything else is more or less noise.