The Flaws of the Facebook Float

By Alex Brummer, June 8, 2012

The idea that Facebook customers and the public would benefit from the social networking site’s initial public offering was always a fallacy. Facebook founder Mark Zuckerberg may now be the richest newly-wed in the world but the 16 billion-dollar-man did not achieve the impossible without being ruthless.

Even so, the long awaited flotation of the company he built could not have been more chaotic. Behind the pictures of Zuckerberg, the whooping workforce and the celebrations, serious errors were made at the launch leading to a big slide in the share price. Instead of reaffirming the site’s status as the most important newcomer in the digital space, it has reaffirmed doubts about whether the world is facing another meltdown, as was the case in 2000.

Almost everything that could have gone wrong with the IPO did. This was not necessarily Zuckerberg’s own fault. But some of the decisions taken by his executive team, notably chief financial officer David Ebersman, did not help. The new CFO was brought in to Facebook because of his experience of publicly quoted companies and with the endorsement of investment bankers Morgan Stanley. But he looks to have blundered.

The first mistake may well have been launching the firm on New York’s tech market, Nasdaq. Admittedly, this is the place that many of the tech companies call home but most begin as minnows and grow on the market, whereas the Facebook float, valuing the firm at $100 billion, was the biggest the Nasdaq has ever seen.
The result was that initial trading in the shares of Facebook was delayed because the market could not handle the volume of buy orders. In the days before the float, brokers around the US, with the encouragement of underwriters, raised the limit on what individual private shareholders could buy from 500 shares to 5,000, a surprising development that should have raised alarm bells. Orders also came in from index funds, and there was a surprising strong interest from wealthy Asian investors.

The sheer volume of trades, and the unexpected sell orders from existing holders, caused mayhem for Nasdaq. Initially, the trading platforms froze and when finally the buy orders came flooding in an hour later the shares soared above the $38-a-share upper range price, before falling back sharply. By all accounts the Nasdaq systems were incapable of handling the volumes. Indeed, after this farce it is now being suggested that Facebook might abandon Nasdaq for the New York Stock Exchange.

The second and more important error, that has led to a flurry of lawsuits and inquiries by the securities regulators and Congress, is over the prospectus. One of the fundamental principles behind the public market for shares is that all investors, whether professional big battalion investors or ordinary private investors, have access to the same information about the company in which they are investing.

All the indications are that this principle was breached in the case of Facebook. In the final days before the flotation the leading underwriters Morgan Stanley (MS) and sub-underwriters Goldman Sachs (GS) and JP Morgan (JPM) were briefed by Ebersman on new commercial information. Second quarter revenue forecasts in the prospectus would not be met because of technical difficulties in moving advertising from PCs, iPads and laptops to mobile devices.

This was particularly valuable information as one of the main questions that has been posed about Facebook’s future has been on its ability to transfer its commercial model to cell-phones. At present Facebook can be accessed on mobile networks, without the commercials. MS, GS and JPM immediately set about briefing valued clients on the changed revenue outlook in the belief, presumably, that the information would trickle down through the sub-underwriting ladder to investors before the IPO was launched. The suggestion is that it did not, provoking a series of high profile lawsuits.

It may also explain why in the days following the offer, the share price plunged more than 20 per cent against the offer price, largely because of the disinterest of professional investors leaving the private punters nursing big losses. The stain of the float will be hard for Facebook to shift.
More serious worries for Facebook investors are about its ability to turn its 900 million subscribers into income sources. With that number of subscribers even a micro-charge could be highly profitable. But the history of social networks is strewn with casualties from Napster to MySpace. Moreover, Facebook’s mining of personal data to sell goods to like-minded people might be seen as intrusive. There is also the worry that new technology such as Instagram, the photographic manipulation app that Facebook is buying for $1 billion, could weaken its hold on the market. Facebook will forever be having to buy-up potential rivals, draining capital and income away from investors.

For now, the critics of Zuckerberg are in the ascendency. But no one can take away the achievement of creating a $100 billion enterprise, in your twenties, from a Harvard dating website.

Alex Brummer is City Editor of the Daily Mail and author of Britain for Sale published by Random House

Last updated: 9:08am, June 8 2012