18 Bucks!? Since the initial public offering of Facebook stock, the price has dropped precipitously, from a starting point of $42, to a new low point today of $18.40 (as of this writing). To get an idea of the IPO process itself, you can refer back to the article I wrote on the Facebook IPO process back in February.
Why Did Facebook go Public Anyway?
As I wrote in my previous Facebook article, there are a number of reasons for companies to go public. In Facebook’s case, they had plenty of cash for operations, didn’t have debt to restructure, and the founder wasn’t retiring. The primary reason was to “cash out” the hundreds of private equity holders – namely employees – that had been promised a public offering to monetize their shares.
Selling it to Main Street
Before we get to the price slump, it’s important to understand the parties involved in the IPO process. It’s a complex exercise, but to keep things simple, we’ll boil it down to the IPO company (FB) and the underwriting consortium. In this case, the lead underwriting firms consisted of Morgan Stanley Smith Barney, Goldman Sachs, and JP Morgan. There were another 30 or so investment banks hired into the consortium to help sell the shares to the public. The role of the underwriters is to essentially get the shares to market by selling them to institutional (Wall Street) and retail (Main Street) clients.
“UnLike”
OK, speed-round - here it is in a nutshell:
Facebook needs to cash out their employees and owners, so they hire the big brokerage firms to take them public;
Big brokerage firms do everything they can to pump up Facebook to the public in order to create “buzz” and get the maximum stock price at the point of the IPO. The underwriters get a percentage of the “take”, so the more shares they sell at a higher price, the higher the fees to the brokerage firms;
Moments before Facebook stock is set to go public, Facebook executives reveal to the brokerage firms that their revenue and profit forecasts are not as optimistic as they once thought. FB and brokerages are forced to cut forecasts, and amend their S1 filing (a required SEC document). However, the analysts at the brokerage firms reveal this new (material) information mostly to their largest and preferred investors (a no-no);
Facebook quietly increases the number of shares available for “common” investors to buy, while at the same time existing shareholders of then-private FB stock increase the number of shares they plan to SELL when the stock goes public. Several large, institutional investors reduce the number of shares they plan to buy. This is peculiar, since one would expect the “smart money” investors to be big buyers;
FB stock opens for trading and promptly loses $4 off its stock price on the opening day. Subsequent days see additional losses and investors are perplexed as to what is happening. Facebook continues its “death spiral”, dropping all the way to $18 over the course of the next 3 months. Stock losses are exacerbated by continued selling by insiders;
In order to save face and keep the stock price elevated, Morgan Stanley (lead underwriter) becomes the single largest buyer of FB shares, with 8 of the top 9 mutual funds in the nation that hold FB stock being managed by Morgan Stanley. Investors in Morgan Stanley mutual funds left holding the bag on substantial price drop.
So Why is Facebook Not Performing Better?
Quite simply, Facebook is having a hard time turning their hundreds of millions of users into revenue-generating customers. Most FB users take advantage of the free services of Facebook. Only a minority of businesses use the service to place ads or buy value-added services.
The majority of Facebook’s revenue comes from banner ads being sold to advertisers. This has become problematic, because, as Facebook has acknowledged, more and more users are utilizing smartphones to access the FB portal, and it is virtually impossible for Facebook to run banner ads on mobile devices.
Now the single greatest challenge for FB is to find a way of generating substantially more revenue from their users. It is doubtful that most users would ever agree to pay for use. And it is also doubtful that mobile advertising will ever become a reality in any material way. The most likely outcome is that Facebook will find a way to sell demographic user information to 3rd parties. Of course, this is pure speculation at this point, but all indications point in this direction.
The Bottom Line
FB is currently generating just north of $4B a year in revenue. The stock was originally priced at the IPO as if it had the potential to become a $25B+ company over a relatively short period of time. As reality set in, it became clear that it will be a challenge for Facebook to become a $10B company, let alone a $25B company.
There is much more to come over the next few months, as there are an additional several hundred million shares that can be sold on the open market (by insiders) between now and the end of the year. Fortunately, CEO Mark Zuckerberg has indicated that he plans to sell none of his shares during this period, other than amounts necessary to cover his tax bill for the IPO.
This will be one of the most closely watched stocks over the coming months, so strap in for a bumpy ride!
Robert Henderson is the President of Lansdowne Wealth Management in Mystic, CT. His firm specializes in financial planning and investment management for individuals approaching retirement or already in retirement, with an added focus on the particular needs of women that are divorced or widowed. He is an Accredited Asset Management Specialist and a Certified Divorce Financial Analyst. Mr. Henderson can be reached at 860-245-5078 or bhenderson@lwmwealth.com. You can also view his personal finance blog at http://lwmwealth.com/blog and the firm’s website at http://www.lwmwealth.com.
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