“Facebook Prices IPO at Record Value” reads the WSJ headline of May 19, only to gain the distinction of a failed IPO just one week later. How did Facebook’s IPO go from boom to bust so quickly? Facebook’s initial public offering failed because it lost 13% of its initial value in the company’s first 5 days of trading – the worst performing large cap IPO in a decade. So, what is the “value” of Facebook? How do you truly qualify the value of just shy of 1 billion set of eyeballs? Is it $104 billion dollar valuation that Morgan Stanley placed on the IPO pricing or is it $67 billion, based on the closing price of the stock just 3 days into Facebook’s trading history? The answer rests in the factors that have sent Facebook’s newly listed equity to lower levels, which unfortunately raises even more questions about how we value companies.
It’s almost an understatement to say there was as lot of interest in Facebook’s IPO – it was what many investment bankers would describe as significantly oversubscribed. Over 1,000 institutions had indicated interest in purchasing stock on the deal. The rumors claimed the deal was 20-30 times over subscribed by institutional accounts alone, not taking into account the million plus individuals who were interested. Put simply, this meant that there were too many people wanting to buy the stock upon its release. Most certainly, the market would have welcomed a decision to increase the number of shares in the IPO by 25%, three days before the pricing of the deal. In fact, the company and the underwriters anticipate this when they issue the prospectus and authorize an additional percentage of shares to be issued if there is demand. In this specific case, given the nature of the institutional demand alone, the company and underwriters were under serve pressure from the investment community to increase the number of shares.
On the 15th of May when David Ebersman, the CFO of Facebook, decided to boost the size of the deal, he was acting on the knowledge that interest for the initial public offering was oversubscribed by 20 times. Morgan Stanley and Mr. Ebersman agreed to execute the greenshoe, which allows the underwriters have extra shares, in Facebook’s case, 63 million shares, available to either sell or buy for a period after the IPO. If demand is strong, they sell them like all the other shares. But if the stock price falls, they can buy them back, effectively creating a floor for the price. On Friday, May 19th, when the stock opened to trading, Morgan Stanley wisely used it’s greenshoe position to “create and orderly and stable market”, balancing the buyers and sellers in the shares of Facebook while 567mm shares traded hands.
But what many investors did not know was that limited information was given verbally to select brokerage firms regarding a shortfall in revenue and earnings in there current quarter. To make matters worse, the information was shared with a select few large institutional accounts. The news that verbal disclosures had been made during roadshow meetings with investors hit the street over the weekend of the 20th, which caused havoc in the stock as it entered it’s first full week of trading. Why was the information not disclosed? What does current regulation require when there has been a material change in financial estimates?
The Securities Act of 1933 states that the information could not be distributed in writing or by newswire. Should Reg. FD have forced Facebook and it’s underwriters to disclose all of the new information? Not necessarily. Prior to an initial public offering the legal rules around selective disclosures during the “quiet period” are very unclear. Given that Facebook was still technically a private company while meeting with investors, they could and should disclose as much as possible. To add to the confusion, companies meeting with investors during a road show or prior to their public offering, are allowed to reveal all sorts of information that they don’t disclose to the public and the advisors and bankers are held to confidentiality agreements that do not allow them to pass on the information.
To quote Henry Blodget “It’s almost certainly not illegal. But if you look at the FINRA rules about such things, it definitely violates the spirit of the law. For instance, the rules say that Morgan Stanley analysts weren’t allowed to show Facebook their research before it was published — but they don’t say that Facebook can’t quietly whisper in Morgan Stanley’s ear that its estimates might be a bit aggressive. Obviously, there’s no need for the analysts to give Facebook advance notice of their earnings downgrade if that earnings downgrade was a direct consequence of something Facebook told them.”
So if you were one of the retail investors “lucky” enough to get an allocation of stock on the deal, you were not aware that the lead underwriters had changed their estimates, at the same time based on changes in the revised IPO prospectus. But you were subject to the implications that the information would have on the stock. For many investors, institutional and individual, you were subject to the antiquated rules and regulations of the securities act of 1933. Not exactly the answer you want to hear when your investment has lost over 20% of its value from its high.
Is there an instant remedy to the situation? No. What happened here was like a perfect storm of unintended consequences. The only true remedy rests with the restoration of Glass-Steagall and updating the regulations originally put in place with the Securities Act of 1933. My fear is that Congress will rush to point fingers and place blame, and that oversimplification defies the complex nature of the IPO market. It’s kind of ironic that Facebook the very company known for bearing all in public, finds itself reeling from transparency issues.
My hope is that Washington will not need to make Wall Street the bad guy, as I fear they will, or once that’d done, they can take a substantive look at this. What Washington should do is start again. Rather than react, we should be proactive. With the vast majority of the regulations written around Dodd Frank not finished, maybe it is time to reverse the reactionary course of the bill and write a bill that addresses the many forms of communication we use today that weren’t around in 1933. Some of the rules around what can be said, when, where and to whom need to be updated for, ironically, the Facebook era. We need to acknowledge the need to define transparency, making the definition consistent across all of the laws that govern the securities markets.
We as a country value that we were built by entrepreneurs like Mark Zuckerberg. If we want to sustain growth in our economy of any nature, we need to understand the workings of free markets and also the regulatory underpinnings that allow for trust and solid business practices. But fixing the Facebook IPO by trying to regulate morality will only create more confusion.
– Christa Carey Dunn