Facebook Handled their IPO Exactly Right
blogmaverick.com
blogmaverick.com
That was probably my favorite part of the article. He screwed up and took responsibility for it! I'm not sure whether I should be impressed that he did or surprised that that taking responsibility for your behavior is so rare when everyone is always looking for someone to blame.
I understand how stock market works and I also understand we need stock markets for huge projects that require billions of dollars in investments. But other than that, it is just one sucker trying to find the next sucker, offload his stuff as fast as he can, for as much gain as he can. The whole thing feels a bit odd.
This is where the gambling comes into play, but it's foolish to think it could possibly work any other way. Take the following example:
Say Congress passes a law that seriously hurts FB, and it will only go into effect in 3 months. There's a very small chance that FB will be able to successfully lobby its case, and a large chance that the law that has passed will go into effect.
Now, do you expect everyone to trade on FB's current "fundamental value"? Anyone in their right mind could see the changes that are coming and will price the stock accordingly. If they didn't, there would be huge arbitrage opportunities for anyone that could short the stock today and buy it in 3 months.
Now imagine that the certainty is less clear. Your own discounted cash flows model relies heavily on growth rate; a change in growth rate today disproportionately affects future potential a few years down the road. There are a lot of things to pay attention to but growth is probably the most important in the DCF model.
Everyone is trying to guess where that growth rate will go, and nobody can predict the future. Hence, a stock that can be volatile and not priced on its "fundamental value" according to you.
If you disagree with this, I would suggest you propose something different that would actually work.
In the same way, the success of facebook.com doesn't create any income for people holding FB shares, it just makes it psychologically easier to flip them. The price goes up for no better reason than everyone assuming it will.
The stock market has become a casino where self-perpetuating phantasms create noise that swamps the signal. I can't blame any company that fleeces willing speculators rather than try to sway value investors using actual yields. I'd love to propose a fix but I don't have one.
If we're going to talk about an IPO as selling a product, we should be clear what this product is - a golden goose. The goose itself has some value in of itself (e.g. the company's assets), but the real value comes from the golden eggs the goose produces. Now, an owner of a golden goose could give you a good idea as to the number and rate of eggs that's come out of the goose to present day (e.g company's S-1 filing), but there's no guarantee that the goose is going to produce eggs at the same rate (maybe the goose dies from gold poisoning, or maybe the goose goes on an egg laying spree.)
The point is, the buyer and seller have to come to an agreement on what's a fair price for this goose. They both have different goals when pricing the goose, and there's nothing to say either of their pricing is accurate, since we're talking ultimately about modeling future events.
So who's really complaining about getting screwed? Long-term investors? Doubtful - if they're in the stock for the long term, then they have to believe that FB will rise in value. They're loving the stock bottoming in that they can buy more at 1/2 price. Traders looking for a bump? Well, it's a trade - for every buyer who thinks FB is going up, there's a seller thinking it's going down. Why would FB under-price their stock and let others pocket money the IPO was supposed to raise?
Retail investors might have a gripe with advisers who pushed them into FB stock blindly. Maybe these advisers are trying to deflect their client's anger to FB.
"Screwing" the buyer implies some sort of dishonesty. If I see an inferior product at an inflated price, I don't buy it. The only way the seller would be at fault is if they lied to me about it.
Something's only worth what people are willing to pay for it. If there wouldn't have been any buyers at that price, they would have had to lower it. But there were, and they didn't.
Distinguish this case from one where I have knowledge that, say, my house has a cracked foundation. The buyer never checks, and I never tell him. Have I done something wrong in this case?
On the other hand, given that he most likely did not take a large position in Facebook shares, and that he made his fortune by selling broadcast.com (http://en.wikipedia.org/wiki/Broadcast.com) to a suitable sucker, in this particular case, his opinion reflects enlightened self interest just as much as refreshing honesty.
Whatever you may think of Cuban's caveat emptor stance regarding investor protections, he's right about Facebook's role in the IPO. The CFO's first duty is to the firm, and in this case it appears that Facebook made aggressive decisions to ensure that the IPO benefited them first and foremost. Which, ironically, serves the long-term best interests of outsiders who want a stake in Facebook.
Great oxymoron.
If an IPO "pops" post-IPO, and during a defined period of time the underwriters essentially underwrite, a.k.a. insure, the offering at the prospectus price, the appointed underwriting banks have a capital loss in the transaction. In dozens, if not +100 IPOs, underwriting banks have lost money.
Not this time though. Someone who worked on the deal at JP Morgan told me one of the big causes of the problem was that the clients in on IPOs usually ask for ten times as much stock as they actually want under the assumption they'll only get a small amount of what they ask for. With Facebook there was such a huge quantity that they actually got it and freaked out. But that's one data point from someone with a lot of incentive to self-justify.
Along with their earnings, revenue and user base no longer growing quickly there's little reason why the stock still supports such a high P/E. Definite downward momentum.
Sure, enthusiasm may be low, but heir enthusiasm doesn't pay bills or keep the lights on. Financially it was a good move for FB. Whether or not it was a good long-term move is still tob be seen.
But also important (and I'm not sure this is realistically possible but I will throw it out there) is to take into account the negative consequences of the stock tanking and creating strong negative publicity against facebook (which it certainly has) which could create a longer term problem. Along the lines of "pigs get fat, hogs get slaughtered".
In other words had the stock been priced more reasonably is it possible that it might have not headed down but headed up? And has the fact that it has headed down creating damage that goes beyond the obvious (time will tell and possibly a lesson will be learned).
$10Bn buys a lot of knob-turning time to get the numbers up.
At what point is a company responsible to its shareholders?
Like always, love his rationale and thinking. I never understood people's view that facebook needs to be obsessed with the stock price (apart from the mentioned employee options). That might just be the naive youngen in me, but what facebook should, and in my opinion does care bout is its product line and users.
I'm really not seeing any employee downside other than some punctured dreams - and I don't see how those dreams would have been any less punctured if they had IPO'd at $10 and moved to $18.
A poorly performing stock price matters a great deal. It matters in the leverage you have with partners, retaining senior leadership, hiring new employees and overall day to day morale in the office. So maximizing the short term cash ramp has left FB significantly exposed over the next 24 months. YHOO is a fantastic example of what happens if your company suddenly has the aura of "loser" in the Valley. (Hopefully they'll turn that around but jury's still out)
So rather than absolutely maximize the short term gain FB could have found a middle ground that wouldn't make them the punching bag of the media resulting in long term risks to employee morale and retention.
Yahoo isn't considering a loser in the valley because of their stock price. It's because no one in the valley uses their products. That isn't true for Facebook.
Cuban is right in that the Facebook IPO was great in that they sold their shares for higher than what they were worth and maximized the benefit for FB.
But the more important fact is that investors, who are the lifeblood of this entire market, got fleeced, and that's long-term bad.
The people that you do business with MUST have confidence that you will live up to your end of any deal that you make with them. If you're only going to do a single one-shot deal with someone, I suppose it's doable to screw them for whatever they're worth. That seems to be the Wall-Street-style business model that is popular with some people these days.
But if you intend to do business over and over again, screwing everyone you deal with is a great way to go broke very quickly. As well, if you attain the reputation of being someone that is bad to do business with, then you will suffer as well.
Do you think Andrew Mason is going to get as good of a ride on the next company once Groupon fails? How difficult will it be for Facebook to have another secondary if it needs to raise more capital?
My guess is that any new deals underwritten by Morgan Stanley will get a second look-over from any potential investors, given the fact that they really sold some snake oil with FB at $100B.
Also, it's interesting that when facebook pulled one over on the bankers, "they got screwed", but when the bankers do it to everyone else, it's "business as usual."
Of course Facebook isn't going to get valued as highly the next time through - THEY KNOW THAT - and that's why they got as much out of their IPO as they could.
FB didn't pull one over on the bankers. The bankers and FB sold their shares to investors, so both parties are "guilty" to some extent. Investors are guilty for believing the hype as well, but in any deal, the buyers have a lot more power than the sellers, so keeping the investors happy is important for a healthy market.
The deal FB made was they tell everyone about the business, everyone else prices it. It's not Facebook's fault investor screwed up their end of the bargain.
The underwriters priced it - at what CFO told them he wanted. That's not usually how these things work (imagine a bank ignoring a property appraisal in favor of what you tell them the property is worth), but the banks are shells of their former selves and needed this IPO and all the promise it held pretty desperately. They protected themselves with the greenshoe/naked short, and retail investors got left holding the bag.
Maybe it's not "fleecing" per say, but it's not the kind of financial engineering an enterprise thinking about delivering long term returns to its investors would do.
As an aside, high beta (volatility) stocks generally don't perform as well, long term, as do consistent growers with stable price action.
I'm pretty sure engineers are the lifeblood of this market. But then again, I'm old-school.
Bullshit. FB/Zuckerberg didn't lie in the prospectus. It was all laid out there and the writing was on the wall.
I also own shares (at a slight loss / breakeven). It wasn't fleecing in the least.
Same with GroupOn. Anyone who feels "fleeced" there is an idiot.
Any "damage" done to the tech sector by Facebook's IPO is probably a net positive for Facebook if it increases barriers to entry. So, they win there, too.
He's also correct that a company can reprice their options.
But all of that misses the point.
Later employees can have repriced options so they're no longer underwater but you have to remember that a lot of people went to Facebook in the latter days for a pre-IPO payoff that didn't eventuate. If their vesting options look little different to an RSU package they'd get from Google, there is no "golden handcuffs", which is what you really want for talent. If Facebook has to reprice their options to recreate that situation they may end up spending a lot of the cash they gained for the high IPO price.
Second, every company, every lawsuit, every war has a narrative. That narrative is important. If you're trying to get people on your side, the facts typically don't matter, the narrative does. Pre-IPO, Facebook's narrative was of going from strength to strength to the point where it had competitors scared that Facebook would be the Internet.
That is no longer the case. The spell is broken. Investors have realized this. No longer is Facebook the company with blue sky potential. It's (now) a company with a really high P/E ratio. Google, for example, peaked in 2007. Part of this was the highs of the market but part of it is also this shift from blue sky potential to viewing the company as a source of income. All this even though Google is making way more money than in 2007.
So Facebook may take years to regain the IPO price. Watch out for the pundits who see the $38 IPO price and consider $18 cheap. The first price we see for something tends to imprint strongly and we view all subsequent prices in those terms. It's a trap that could well lose a lot of people a lot of money.
Beyond employee and investor issues there is another problem here: companies tend to prefer to pay for acquisitions with stock rather than cash (eg Instagram was, at the time, $700M in stock and $300M in cash IIRC). If the narrative of your stock is one of it having consistently dropped since the IPO, it makes it harder to pay for acquisitions with stock as investors and founders have to price the stock based on expected losses rather than expected gains.
The key motivations in any market are fear and greed. If the stock has a history of going up (like Apple's in the last decade) then greed takes over and people want to get in. In Facebook's case, fear would be a significant factor now (given lock-ups of shares on acquisition, etc).
The problem with Facebook IMHO was that it waited too long to IPO. Of course as a colleague of mine likes to say, "that train has sailed" [sic].
One thing I that makes me chuckle is thinking back to the prices paid on secondary markets pre-IPO. Staunch FB defenders argued this was useful price discovery (one function of any market). Others (including me) argued that such markets were essentially echo chambers and the stock was too thinly traded to give meaningful price information. That view has turned out to be correct.
The best part of this whole story is that the wider market hasn't bought into the hype and has discounted Facebook stock accordingly. Any concern of us being in a bubble should go out the window.
It's Becoming Clear That No One Actually Read Facebook's IPO Prospectus Or Mark Zuckerberg's Letter To Shareholders
Quick hits from the article
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Didn't anyone even read Facebook's IPO prospectus? The answer, I can only assume, is "no." Because if anyone had read the Facebook IPO prospectus, they would have learned, among other things, the following:
Facebook's growth rate was decelerating rapidly.
Facebook's user-base was rapidly transitioning to mobile devices, which produce much less revenue.
Facebook's operating profit margin was already an astounding 50%, which suggested it had nowhere to go but down.
Facebook's CEO had a nearly unprecedented amount of control over the company.
Facebook's CEO had set up this astounding level of control intentionally. Mark Zuckerberg knew all about how impatient public-market shareholders are. And he set up the whole company so he would never have to pay attention to their whining.
In the 9 months following the IPO, insiders would be free to sell more than 2 billion shares of Facebook that they had been holding for years.
Facebook was going public at an astoundingly high price for a company with these characteristics—about 60-times the following year's projected earnings, in a market in which other hot tech companies like Apple and Google were trading at less than 15-times.
http://www.businessinsider.com/facebook-stock-letter-shareho...
Facebook's CEO had a nearly unprecedented amount of
control over the company.
I was under the impression that Larry and Sergey did the same thing with Google. As I remember they always retained more than 50% of voting rights, and now there's a new special class of stock issued to shareholders with no voting rights.
Thing is, shareholders can be irrational, especially with companies that are working on the cutting edge, because shareholders are more interested in short-term gains. E.g. Shareholders and Wall Street were thrilled when Dell was outsourcing their core competencies to Asus, which in the end screwed them over. Dell is now just a shadow of what it used to be, with no bright future ahead.
Of course, if you view that as a warning sign, then simply don't buy. But there are other factors at play here. Do you trust the company? Do you trust the CEO? Do you understand the risks? If not, then maybe you shouldn't own stock in the first place.
Nope. The article does explain this. None of the bullet points are meant as criticism.
Again, Mark Zuckerberg set up the entire structure of the company so he wouldn't be forced to make dumb short-term decisions by whining public-market shareholders. And he TOLD them that he wasn't going to make those decisions.
They just didn't listen.
The article isn't an indictment of Facebook, its an indictment of investors who ignored the warning signs that this wasn't a stock designed for a short term position and are now complaining about it.
Many people bought into the idea that Facebook had yet to scratch the surface with revenue opportunities. Obviously, the market has not shared this view.
EDIT: I am wondering though, if the artificially high price was a ruse - a scam used by those who COULD sell at the overly inflated IPO price to cash out tons before it dropped to what they knew was the correct reflection of value.
I'd be willing to bet this was the case.
If people do it through an 83(b) election, aren't these RSUs supposed to be taxed as cash at the second of grant? (but if forfeited, that tax is lost?) - That would be horrible.
If people don't do a 83(b), then it is taxed at vesting - so it's just equivalent to a cash bonus at exercise (and taxed the same) - but if that's the case, how has anyone ever thought it was anything other than a cash bonus (determined at bonus time by a constant C*company value for some C, which appears in your employment contract, but is otherwise arbitrary and can be changed arbitrarily at any point before grant by the company)
if the stock price goes up, you are golden, as you started your long-term capital gains clock earlier.
But what if the stock price goes down? Then you just paid taxes based on a $38 share price, and ended up with shares worth just $18. If the stock price goes down a lot, you may end up paying more in taxes than the value of the shares themselves
(a) vested all shares (usually 2-3 years)
(b) sold all your shares (was practically impossible for FB employees before 2nd market and friends came along; still mostly impossible for employees in most companies until 6 months after IPO or acquisition)
(c) have realized capital gains in the year(s) following that loss (I don't recall the exact details, but you can net the full loss for 3 years, and then less and less until nothing at all in 7 years or so).
Now, let's look at a more typical case:
You start to work at facebook the day of the IPO; you are awarded 10,000 RSUs at $38 each. That's $380,000 right there; If you make an 83(b) election (to start the capital gains clock ticking), you just scored $380,000 in the "other income" (or even "salary") columns. If you're in high tax place, like NYC, that's 48% in marginal rate (which is not unlikely -- although, assuming you were unemployed, and this all happened on 31-dec, would "only" be 43% or so ....): 35% federal + 8% NY state + 5% NYC. So you just incurred a tax bill of $180,000 of money you never got.
Now, you can get fired the next day. The shares have been forfeited. You do not have a capital loss in that case. Just a $180,000 tax bill with NO income or credit to offset it, regardless of what happens to the stock.
But let's say you stay working for the whole vesting period. Except the whole time you can actually sell them, they are at $16. You're still $20K out of pocket at the end of the period, after selling everything. (And whatever the interest and opportunity costs for spending those $180K on taxes).
But in this case, if you make a huge capital gain profit sometime in the next three years, you'll be able to take credit for your losses - of having bought the RSUs at $38 and sold them at $16 - a loss of $220K.
Oh, and you often have to pay for RSUs, so your losses are larger (although unlike options, that's not mandated by law, and FB could give them to you "for free").
So, no, you don't want to turn the capital gain clock on RSUs unless the shares are essentially worthless at the time of the 83(b) election [or otherwise have no way of siginficantly losing value, and have a good probability of gaining value).
By all means, you should do an 83(b) election when founding the company (if it is needed and makes sense) - on week one, when the value of the company is $5000, it makes sense to pay taxes on your 25%=$1250. But a few months later, when you're raising money at a $1M valuation, that's the value the IRS will want to see on your 83(b) election.
The companies being acquired will do so at a lower valuation because their upsides aren't as stratospheric as they seemed a few months ago. "If Facebook isn't worth that much, how much are you worth?"
Today Instagram would take $300M cash and $350M stock and be happy with it.
> thinking back to the prices paid on secondary markets pre-IPO. Staunch FB defenders argued this was useful price discovery
I'm no FB defender, but doesn't the IPO placement of 421 million shares at $38 indicate that the secondary markets had it correct? The decline, albeit soon and somewhat swift, occurred afterwards.
This statement should end with "I'd offer him $100K for 50% of his company".
I really like Mark Cuban, but I feel like that show is beneath him. I've seen it a few times and haven't found any teachable moments. His blog, however, is great.
Also, sort of off topic (more related to just Mark Cuban), but I'm surprised he made that "SharkTank" reference. I've always wondered how he viewed his presence on that show. I figured he saw it more of a "charity case" because of his fame. I never realized he actually referenced it and promoted it.
I love Victoria Coren's quote about Rounders:
"Rounders - a film that asks us to believe John Malkovich, supposedly the best player in New York, always eats a biscuit when he's bluffing."
(Coren is a journalist and professional poker player).
The only reason FB stock offering looks bad is because the market crashed for a moment halting the pop. If the market popped people would have nothing to say.
Cuban is spot-on.
Using Cuban's own auction analogy, he was basically defrauded by buying a 'fake' collectors item, and thinks the fault lies with the purchasers (for not recognizing a fake when they see it) not the sellers or the auction house for perpetrating this ruse.
Paul.
That was the very bottom of the market. Googles issues were macro. And the high-water mark in GOOG before that event was set by investors, not underwriters.
But fundamentally I don't think FB did anything wrong. As an armchair economist it looks to me like Facebook had enough strength in their order book to justify their $38 IPO price. You can't blame them for trying to maximize their one-time-only uber-billion-dollar liquidity event.
FB may have put $10 billion in the bank, but the market took $50 billion out of its value. Not exactly a win is it?
I own FB shares. I think the company will figure out a killer revenue model like Google did. But I don't blame FB for the temporary loss in stock value and it's NOT their job to make the stock price go up. Their job is to make revenue and profits, and I want them to focus on that.
If the CFO deliberately acted to benefit future shareholders at the expense of current shareholders he'd have violated his fiduciary duties.
Not if your CEO has the controlling interest.
In theory, Zuck can let the stock drop to near zero, and then take the company private by buying outstanding shares for pennies per share.
And there's nothing the bozos with common stock can do about it.
> Not exactly a win is it?
It's a huge win, because that $50B has nothing to do with the company coffers, and has everything to do with the suckers who bought the common without serious voting rights.
They have a responsibility to provide accurate information about their business, but the valuation is ultimately set by the market, not them.
'Google gives away free lunches to employees, but that didn’t compel everyone else to do it,” he said.'