Just four days after it went public on the stock market, Facebook became the center of intense attention Wednesday -- both on Wall Street and in Washington -- as shares hit $32, well below the initial offering price. Jeffrey Brown, Dartmouth's Anant Sundaram and Rob Cox of Reuters Breakingviews discuss what went wrong.
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Just four days after it went public on the stock market, Facebook is the center of intense attention again on Wall Street, in Washington and elsewhere. But, this time, the focus has a very different tone.
When Facebook founder Mark Zuckerberg celebrated the public stock offering of his company at the Nasdaq opening bell on Friday, expectations were positively giddy. The social media giant with more than 900 million users worldwide began trading at $38 a share, and the price initially shot up on heavy demand.
But it didn't last. The day ended with Facebook trading nearly where it began. And, in the days that followed, things got worse, with Facebook's value falling nearly 20 percent.
The fall put a spotlight on Facebook itself and Morgan Stanley, the lead bank underwriting the IPO, about initial pricing decisions, disclosures and whether some clients were favored over others. And the Nasdaq exchange also faced questions, after technical glitches and other problems affected trading.
Congress and the Securities and Exchange Commission have both promised investigations.
MARY SCHAPIRO, chair, Securities and Exchange Commission: But there are issues that we need to look at specifically with respect to Facebook.
And a group of shareholders has also filed a lawsuit against Facebook and Morgan Stanley.
Facebook did manage to close up today, hitting $32 a share, but still well below its initial offering price.
And we tackle some of the questions and investigations surrounding all this with Anant Sundaram. He teaches business administration at Tuck — at Dartmouth's Tuck School of Business. And Rob Cox, U.S. editor of Reuters Breakingviews, a financial news website.
Well, Rob Cox, when we start to look at what went wrong, start with Morgan Stanley and the other underwriters. What's their role and what questions are there now for them?
ROB COX, Reuters Breakingviews:
Well, in any IPO, what you try to do is balance the demand for the stock from institutional investors, like big pension funds and hedge funds and some retail investors. You try to get the right balance so that you price it appropriately so that, you know, in the first day of trading, it doesn't go way up in the sky and pop, like it used to back in the big Internet IPO days of the late '90s, but also sort of doesn't decline like we have seen with Facebook.
And it's a really delicate balance. It's a very difficult job. But, you know, generally you try to get it right so that everybody's happy at the end of the day. You don't have four days later everybody talking about a botched IPO, a problematic IPO. You don't have Mary Schapiro and the SEC and all sorts of regulators jumping in on it.
And that just — that clearly didn't happen in this case.
Anant Sundaram, I mean, what would you add?
These questions about what the understood writer has to tell potential investors, when, what kind of information is important, what would investigators be looking at in a case like this?
ANANT SUNDARAM, Tuck School of Business, Dartmouth: It is at this moment alleged that there might have been some information asymmetry that might have been exploited by some with favored access to that information.
I have only seen allegations so far, but let me first say that, yes, there's a lot of criticism about this IPO and Morgan Stanley. But from an issuer standpoint, we have to recognize that this was a huge success. And Morgan Stanley's job, we should recognize, is to maximize the proceeds to the issuer.
So, to some extent, I find that part of the commentary a bit baffling. But back to the information asymmetry issue, what is being suggested is that perhaps in the last minute, there was some information that might have been given to analysts at Morgan Stanley and a couple of other underwriter firms that might have enabled them to revise their forecasts in their valuation models, thereby making institutional investors pull back on their demand for the IPO.
Now, I find it extremely surprising that something like that would happen, but we don't know what the facts are. But I will say this. Facebook filed many amendments to its prospectus right up until the final date of the IPO, which I think was May 18. And they explicitly stated that their revenue has been declining from 155 percent all the way down to 45 percent and that they continue to see declines.
Now, it's not clear to me what an investor looking at that would have guessed, other than to say, well, they expect it to decline further. So it's a bit of a fine line, but we don't have all the facts.
Well, Rob Cox, help us out here. What is the problem, then? Where do you look at with what Facebook did say or didn't say or Morgan Stanley did or did not say?
Look, I mean, I take your point, Anant, about the idea that the issuer — in this case, Facebook and the venture capitalists and people behind Facebook, earlier supporters — had sold, woohoo, $38 a share, $16 billion of stock.
But, you know, on day two, Mark Zuckerberg, the CEO and founder, who had only sold stock insofar as he was dealing with tax issues, and all the 3,000-some-odd people who were at Facebook, they've got to live with this company going forward.
So what might have been a quick win for the backers, the venture capitalists here I think is a real loss for Facebook. We're sitting here talking about how Facebook is sort of up there with Morgan Stanley and the Wall Street money grubbers, as it were, rather than how Facebook is connecting 900 million people around the world, our ex-girlfriends, our old bosses, our parents, all those kinds of things, the creation — the very thing that Mark Zuckerberg tried to avoid by really taking himself out of the frame with the IPO.
Remember, he said all along, I'm only doing this for my investors and my employees, who want liquidity with the stock. In a sense, now he's got more distractions than he bargained for. He's got lawsuits, he's got litigation, he's got Mary Schapiro, he's got the SEC.
He's got us talking about it on television. And we're not talking about what a great creation it is, but what a botched IPO it is. So I just sort of would balance. You know, yes, it was a great deal financially for a few people, but on the broader term, this is not a great thing for Facebook going forward.
Well, Anant Sundaram, what does history tell us about these kind of IPOs, if there is any good analogy? Is it too soon, too early to tell about its success or failure?
Yes. It is too soon to tell us about its success or failure.
But we do have considerable evidence on long-run performance of IPOs in the academic finance literature. In general, on average, IPOs underperform over a three- to five-year horizon, it actually turns out. But, actually, if the evidence, again, on average, is to be believed — and the empirical evidence is pretty strong — that it's the stocks that are large IPOs such as a Facebook that actually tend to outperform, and also stocks that are taken public by "higher quality" — within quotes — in bankers such as a Morgan Stanley or a Goldman Sachs, as opposed to sort of second-tier bankers.
The evidence shows that the extent of the underperformance is less. My personal view is, six months from now, one year from now , which is really what an investor should care about from the point of view of his or her holding and wealth creation and what the intrinsic value of this business is, six or seven months, or 10 months, or one year from now, I think we will have forgotten the first few days. And the focus really will be on whether they're executing their strategies as they need to and the fundamentals are where they are implied by this valuation.
Well, Rob Cox, briefly, what would you — what do you think? We use the word investors. Let me put in sort of small investors that we're talking about. What do you think small investors should learn from all this?
Well, there's a two-tiered market in this country. And a hundred billion dollars of value was created before this thing went public. It was created for about 1,000 people or institutions, and retail investors were really not one of them.
The retail investors are getting a bit of the drag of the market, because you can keep funding these companies through their best growth cycle. And they're getting — they're not getting a great deal. I would say, for IPOs, this is a bad game to play if you're a retail investor generally. Wait it out.
As Anant said, in a year, we will see whether Mark Zuckerberg is able to execute on his strategy to make money from this fabulous creation of his.
All right, Rob Cox, Anant Sundaram, thank you both very much.