The market doesn't care about your overpriced valuation (Failbook)
williamkasel.posterous.comI feel like this article misses a number of points. Firstly, the modern IPO is chiefly about giving early investors and staff an exit ticket. It is therefore in their interests to price it as high as possible. The fact that there was significant hype around the business meant that they were able to achieve this valuation. The fact that this is distinct from the original aim of the sharemarket - that is, capitalising firms to create new ventures (Think infrastructure - the golden age of rail, factories, etc) is an interesting side-note.
Secondly, the marketplace often operates on the stupidity of the masses. Intelligent fund managers stay away from overpriced IPOs, the uninformed masses pile in because they hear the hype and are not value investors so don't know/care that the revenues aren't behind the company.
3- A successful IPO is one that is fully capitalised and gives the company new cash. It is not one that goes through the roof. This would represent a failure of the Merchant Bank to properly capitalise on the company's value (They could have charged a higher value for the IPO as that would have better represented the fair value of the company) - in fact, in a perfectly valued company it should track mostly flat as the investor return is priced into the dividend + some accumulation of value.
The Facebook float, and the Zynga float, and numerous others, thus represents a good example of management and investment banks fully capitalising on the hype surrounding them to extract maximum returns for the early investors. The fact that this screws later investors is secondary.
With all due respect, I completely disagree. If you understand the fundamentals of an IPO, as I explained below you would know that there is a 180 day lock-up period for employees, this means that employees haven't been able to sell their stock yet. When they do sell their stock it will be at $10/$15/share. The only folks who made money on the IPO were Merrill Lynch who SHORTED IT!
You're typically supposed to IPO at the point you are preparing to grow. Not flatline. Your original argument is exactly what I'm saying is the misguided philosophy of Silicon Valley, and the Tech Community as a whole. Again, no offense, but step back and look at what I just said. I have a point. This IPO fucked everyone, including Zuckerberg, employees, and anyone else who still holds shares which as I said above is every single employee.
No, that's wrong, the only way an initial overvaluation hurts pre-IPO investors is if the stock gets delisted, or the market is so offended that it starts caring and undervalues the company. Otherwise, employees are just fine; Since the market doesn't care, it gives them fair value when they have a chance to sell. They lose out on cashing out during the over-valuation period, but that was just free money for those that pulled the strings, pre-IPO investors and Facebook management that could sell at IPO
The only people hurt by the initial overvaluation were the people that bought high. Everybody else wins or is neutral. Everybody. Again, unless the market starts caring about retribution and undervalues them. Otherwise everybody gets exactly what the market will give them.
The ibanks, Zuckerburg, and initial investors that sold on IPO day or shortly after, all win by a huge margin. They pulled the wool over lots of people's eyes; perhaps not intentionally, perhaps they honestly believed their own bullshit, but in any case their irrational exuberance hurt them not one bit.
> but that was just free money
Except the employees would have been sacrificing a higher salary for these shares so they where hardly free.
> The only people hurt by the initial over valuation were the people that bought high
The people that got burnt where those that read the IPO document and assumed it was not a work of fiction. The people that made money where insider trading on information not yet public.
The others that will get hurt are the next set of companies that try to float. The market will be reluctant to make the same mistake again.
Bad IPOs damage the credibility of the market and dmaage the ability of companies to float and that Facebook IPO was just a joke.
Your post kind of suggests that this was the first major company to ever be overcapitalised and incorrectly valued. This is patently not the case. The people that bought into the FB IPO did so out of their own free will. That they believed the valuations is down to the hype surrounding the FBIPO and the hard work of the underwriters to convince investors of the strength of their case. There are 2 types of investors, informed and uninformed. These were uninformed investors. They operate under the principle that they can exceed the average market return (i.e. they don't understand the efficient markets hypothesis).
The market doesn't make these mistakes, the investors do. The market is the mechanism by which mistakes in valuation are discovered, as the IPO trends towards its fair value.
The fact that these are bad for the credibility of the market does not deter wall street for looking out for more sources of revenue (in the form of underwriting IPOs). It may make companies thinking of raising cash on the market think again - ('Is our valuation correct? How can we avoid being overhyped?') but in the long run this is nothing different to what has happened in hundreds of IPOs in hundreds of stock markets in hundreds of companies over the past several hundred years.
It is quite possible to understand the efficient market hypothesis and not believe it. In fact I think that everyone who invests in the market in forms other than tracker funds doesn't believe it holds.
The efficient market hypothesis is a useful thought experiment but the assumptions required for its proof are unrealistic and it doesn't explain real world volatility.
I do think the thought process of 'what do I know that the market hasn't taken into account yet' is a useful one and that if the answer is nothing buy a tracker. The knowledge could be proper research that disagrees with the media about a company.
I like and agree with your point
I have no problem with that fact that the IPO was a disaster. As you point out this has happened before and it will happen again.
What I don't like is the FB prospectus was never a true and accurate representation of the company and everyone on the inside knew this, but they failed to tell the public.
And what's worse is these 'well informed' insider investors then illegally used this inside information to make lots of money since they new the IPO was over valued and went short.
Spot on.
Not true at all.
Anyone hired after their valuation was fairly high who was given options would be given options with a high strike price. If the stock never gets there, those options are worth nothing.
A large part of the people who were hired in the last year, with apparently generous option packages, now have Facebook on the resume and no golden handcuffs holding them. And a lot of other employees who had golden handcuffs are going to be thinking about places to bail. This could give them a significant retention problem.
No, that's not right (might as well make it three comments in a row :)
THere's no strike price on recent Facebook employee's equity; they receive RSUs, not stock options.
Edit: here's an article describing it a bit more: http://www.businessinsider.com/facebook-ipo-stock-price-recr... Due to many different employee's RSUs vesting in very small time window, there could be a whole bunch of other problems with flooding the market, as well as the and tax difficulties for employees that can't spread out their RSU income over multiple years.
I didn't realize that they were using RSUs. That does change the equation.
I would be curious what a tax lawyer would say about AMT liability. But AFAIK you're right, there is no problem.
I agree with your point about every techcrunch etc saying what 'facebook NEEDS to do' - as if you can judge the failure/success of a company 3 months post IPO on the value of a stock.
I continue to disagree with you about this fucking Zuckerberg/Employees etc. They have turned paper money into real money. They have lost - psychologically - some unreal money in their freeze period (BTW I was not aware of this, I am much more familiar with Australian securities law). The ~70 Billion of shares from outside investors (Guestimate, I don't know how much stock was retained by employees) - has capitalised the company however, and these are the people who are getting b*tchsplapped by the invisible hand.
With regard to IPO as you are preparing to grow - yes. But that just highlights the nature of IPOs in a bubble. As another poster said, they have managed to significantly capitalise the company despite the fact that rational investors have subsequently brought the share price back to something that (they consider) is more properly the fair value. the idea that a shareprice should skyrocket post IPO is a fallacy that goes against the Efficient Market Hypothesis - i.e. that in the long run you can't achieve returns that are greater than the average market return. This same fallacy is what most 'uninformed' investors are investing in the market under - and it is the existence of these investors that allows informed investors to make a killing on their behalf - in this case, Merrill (and assumably lots of others) by shorting the stock.
Merrill shorted FB at the IPO? I seriously doubt that. First of all, I don't think there would be enough inventory to borrow for a few days. Secondly, the borrow cost would have been astronomical for those first few days. There was a WSJ article that talked about the borrow dropping from 40% to 6% about a week after the IPO. Are you talking about that period?
No h1srf I don't know anything about merrill shorting it, I was responding to wkasel's assertion in the second post of this thread that they did so. I have done no research regarding shorting on fb in this period.
However Morgans would have made a double killing in the post-ipo period having oversold the allocation and now being able to fill those orders cheaply on the secondary market (assuming they didn't issue new stock to fill the orders)
I back everything up with facts amigo. They shorted it $2.4B.
http://blogs.reuters.com/felix-salmon/2012/05/21/morgan-stan...
Presumably the company has plans to invest the cash raised in the IPO to generate positive returns.
In this case "extract maximum returns for the early investors" means that a whole lot of people got ripped off.
The notion that "the modern IPO is chiefly about giving early investors and staff an exit ticket" is a near perfect example of how "Silicon Valley, I hate to say it, has its head so far up its ass that it's eating its own bullshit."
The investors purchasing Facebook at IPO and after are not looking to reward early investors or hand some sweet exit to a founder.. they are looking for a return on their investment dollars.
If this is the prevailing attitude regarding the purpose of capital markets in Silicon Valley, I would be shocked if the IPO market for new tech stocks didn't shrivel up and die in the next (last?) few months.
How odd that there is an excellent article sharing the front page about American "Looterism" replacing American Capitalism.
Well said. You're exactly right. I didn't cover it, but the larger concern I have here is that this misguided approach could lead to distrust from wall street of any tech IPO's that aren't enterprise, or low/mid cap.
This is not a new phenomenon though. Look at tech bubble #1. hell, go back in time and look at Tulip Mania or the railroad bubble in the late 19th century. Wall Street will continue to do what is in it's interest. With average returns from Underwriting an IPO in the range of 7-9% they have to. Wall Street doesn't care that mum and pop investors get screwed - they just need to know that there are more out there that will continue to buy IPOs if they are presented in the right way.
BTW, IPOs have been in long term decline (in terms of absolute numbers) for ~20 years now - see the economist
The gist of that article is that the number of firms going public or using capital markets to raise equity has diminished in favor of private-equity, irrespective of the number of firms in existence.
Most of the reasoning behind it appears to be that the legal system has been modified in such fashion that it favors other forms of firm structure.
Hardly indicative of any natural decline, it would be easy to take from this article that the Pump & Dump style IPOs (and other massive erosions of trust) are strangling the effectiveness of Capital Markets by scaring away investors and inviting increased regulation.
I think the dot com bubble was the most damaging. Prior to that IPOs were not something the average investor would try to get in to. First day "pops" were modest and the expectation was that a company (even a tech one) should have 8 quarters of steadily improving profits prior to the offering.
Facebook is a once-in-a-decode or -generation thing. Unwise to extrapolate too far on it.
My only comment is that if you can make an overpriced IPO, that is good for you. It is bad for the suckers who were dumb enough to buy in, but that is a different story. If the share price goes up quickly after an IPO, the price was too low. If the price goes down quickly, it was too high, but why should you care? If you want to pay me $1.50 to buy $1 bills, I will sell as many as you will take. The current market valuation only really matters when you want to trade. Otherwise, worrying about your stock price is a bit of a pissing contest. BTW, I did not buy Facebook or Zynga. They were both pretty obviously over-hyped and overpriced (it seems most IPOs in most industries are), but the stock holders prior to the IPO made out like bandits during the IPO.
Logical explanation, however the point of an IPO is not just liquidity in for your employees, but also to raise money for the company, and allow the public to buy in. If you don't price it so the price goes up, then you're doing everyone, even your shareholders a dis-service because they have a 180 day lockup period, so when the stock is at $15/share at the end of lockup, you actually screwed employees as well. The only person who actually made money on this was Merrill Lynch.
Facebook got a huge injection of capital at very favourable rates which was good for all holders prior to the IPO. I understand that it might be disappointing to see your stock go from $38 to $15 over the lockup period, but my point is that it was never worth $38 in the first place, so by getting new buyers to pay $38 for a $15 stock, the current owners increase the real value of their own stake for free.
I will agree, however, that the biggest winner is and probably always will be the investment bank. Well . . . sometimes the bank loses, but not very often if they do their job right.
I believe that Peter Thiel, Accel Partners, and several other early investors sold a considerable part of their shares in the IPO.
That being said, I agree with your article and you make lots of good points!
Yes, typically you have a negotiated rate, such as 5%, 10%, whatever. You're right I saw the s-1, but even then they still lost a lot, and the employees got screwed.
Fair, but the only problem I see with your reasoning is stock grants were being issued as far back as 18 months ago at $25/share, which means that those employees DID lose money.
I don't know much about the FB employee stock plan. If they were given grants, the price doesn't matter. They gained shares of the company. If those shares were labeled $25 when they were in fact worth $15, they can't be said to have lost $10 because they actually netted stock worth $15. You might argue taxes as they would have to pay tax on the $25 income, but when they later sell, they can claim the $10 capital loss. Assuming they are in the same tax bracket, it is a wash.
If they were given options which the employees had to pay $25 to exercise, then yes, the employees lost money. However, they had the same opportunity to make the analysis that any other investor had. No one forced them to exercise their options, and those who did paid too much.
That is the same though as investors buying in at $38. Employees could always choose to negotiate the grants or leave if they think they are bad value.
The root of my argument though is that as Silicon Valley know-it-alls we assumed the world would gawk in awe of our amazing creation and throw money at us, which it did not. It's a shame you can't buy put's on that, because THAT would have been worth it. :)
People did gawk at the amazing creation and throw money at Facebook needlessly, and that's the problem. In a way, Facebook has been able to do a bit of market segmentation, and take the initial money from those that thought that it had the most value, without having to listen to the dissenting voices that think it's worth less. Typically, markets prevent such a great information disparity.
Before IPO, nobody knows for sure what the real valuation of Facebook is. They have their own personal valuation, but the eventual price on the market is going to be a reflection of the combined valuations, it's an average of sorts of everbody's belief about Facebook's ability to make money over the time scale that each particular investor cares about. You can make a price-demand curve out of it; pre-IPO I wouldn't have bought Facebook at any price, some people thought $15 per share, some people $20, some people $38, and some would have bought no matter what.
Facebook was unique in being able to take advantage of this market uncertainty, namely each investor's uncertainty about what everybody else thinks. They shielded the overoptimistic from the pessimists' views, or the overoptimistic didn't bother to acknowledge that there would be pessimists, and Facebook took the optimists' money first. In doing so they got the most capital for giving away the least possible. (This shwredness probably bodes well for their ability to make money in the future.)
Usually tech stocks go the other way because the company doing the IPO has very little leverage to set their own price; investment banks are the gatekeepers and won't let anyone through unless their customers unless they and their most-favored-customers make a bundle on the initial sale. Facebook was able to flip that dynamic around and make sure that they themselves made a bundle while all the investment banks' customers lost out. It takes both leverage with the investment banks and knowledge of the demand curve in order to pull something like that off.
If the overoptimistic end up being right on the long enough timescale, they'll get their money back. But for the moment there are too many pessimists about the future potential of Facebook for a $38 buyer to be able to get what they deem a fair value.
Buy low, sell high, simply means being optimistic when others are overly pessimistic, and being pessimistic when others are overly optimistic. There's a bit of predicting what the objective financials of a company are, but it's far more about realizing the psychology of everybody else with money to trade. It's not just Silicon Valley engineers that are overoptimistic...
Indeed. Despite our disagreement higher up this thread on who gets screwed and why, I did quite enjoy the article. I looked at it more as a cautionary tale about getting drawn into the hype surrounding IPOs in general and tech IPOs in particular. The market is not as efficient as economists sometimes like to pretend, but it does have a central tendency and if the fundamentals don't support the valuation, the market will bring the price back down.
I say, if you can IPO at an overpriced level, do it, but don't believe your own hype and buy into it yourself. You will be disappointed.
Si. I really think the role of history here is important- there is nothing new or especially important about the current burst of innovation, or as Joseph Shumpeter termed it, creative destruction. We are just in another phase of human and economic history- and the valley is a remarkable centre of a lot of this innovation. However the same rules of hype, hyperbole, boom and bust that have governed all pervious cycles of human history still work in the information age. So none of this is new, and it won't be the last time it all happens either!
I don't think it's appropriate to call it "losing money" when one does not have the ability to sell. Probably a bad analogy but it might be like saying a baseball team lost the game because it had fewer runs in the 5th inning.
Blodget made some good points:
http://www.businessinsider.com/facebook-lockup-release-2012-...
You want a high IPO price, but not so high that you can't meet expectations and disappoint. Get tagged as an underperformer and it makes it hard to do future stock acquisitions, financings, hires.
Wow.. to the top level commenters who rationalize the merits of the Facebook IPO as successful in extracting the maximum amount of money for investors and employees.. this is the type of logic that warrants the criticisms thrown at Silicon Valley.
Not withstanding the fact that the redistribution of wealth was based on 'hype' and just a douchy move, does no one seem to understand that the IPO market will inexorably implode yet again through such self-serving actions, thereby closing future IPO opportunities for companies with real revenues and growth?
This is a stupid argument. The character "flaws" the author cites are basically why much of the technological progress of the past several decades originated in Silicon Valley.
Let's not use the word stupid. I live and work in this ecosystem. If you saw what I saw you would agree.
You're lecturing me about language? I've seen as much or more and I think "stupid" is the correct word. The supposed "flaws" you mention are the exact attributes that have made Silicon Valley the originator of much of technological progress in the past few decades. Selecting a once-in-a-decade company to extrapolate from is, well, stupid.
SV was the leader in social media three years ago but today the interesting companies, like Pinterest, are run out of places like Iowa.
I think the people who work at Pinterest's HQ in downtown Palo Alto would say they're not in Iowa anymore.
Nice article, William! :)
Seems a bit snarky to me. Engineers don't price IPOs, bankers do. And because of that it reads more like
"I'm really pissed off you are now rich and I am still not rich."
or perhaps
"I thought it was going to go through the roof and so I bought some and it didn't so I lost a lot of value and now all this stuff that I'm reading makes me look stupid for having believed it in the first place."
I've mentioned elsewhere that when I read stuff like this I feel sympathy for the Author because I think they might be in a lot of pain over something and trying to work through it. Not everyone has good tools for that, sometimes just screaming at the top of your lungs makes you feel better.
As a person who lives in Silicon Valley and could easily be painted by William's broad brush strokes as someone who "has their head so far up their ass that they are eating their own bullshit" I regret to say that I've not lost (or gained) any money on Facebook stock, don't own a single share, and like a lot of people here don't own it because I didn't feel it merited a price over $30 a share. This isn't because I'm a genius and or smarter, its because I looked at the business and said, "You know I don't think it supports that valuation."
But that said, its a hell of a business. Facebook made over a BILLION dollars last quarter, that is over four billion a year at those rates. I was at Sun 10 years and it just just crested $3B on its ways "hopefully" to $5B and folks were estatic. It is pretty impressive what these Facebook folks are doing.
But what William is so upset about is its stock price. And to that I'd say why the hell do you care what the price of Facebook's stock is? What does it matter? Smarter people than you are evaluating it every day and making bets on whether its priced higher or lower than its future value, as they play that game they exchange money, it's sort of a score keeping system with them, and they have more strategies than a roulette player has ways to "beat the house."
Now if you're an executive at Facebook you care because it limits your options when it goes down, as an employee maybe it changes the model plane or boat you can buy, as an outside observer it means nothing. So why the angst?
Interesting assessment. I live in Silicon Valley, I don't own a share of FB, I do trade frequently. Like you, I made an assessment. My frusteration comes mostly from reading on tech blogs what Facebook "needs to do". Techcrunch acts like they are Bloomberg or something, which goes exactly with my broad brush stroked point as you said.
It's actually the valuation I care about vs. the stock price, but people tend to understand that better, so I use that as a unit instead of valuation.
The bottom line is yes, I write pointed, and passionately, I'm not personally at a loss for FB, I'm just tired of hearing "expert opinions" even on Bloomberg.
Ok, I think it would be more effective for me then if you started with what you cared about and why you cared about it.
So your frustration is with blogs, written by people who are paid in proportion to how angry or scared they make their readers, using Facebook as a stalking horse to drive page views? I can certainly understand if that is the case, why not say that?
Instead you said this : "The root of this problem is core to the DNA of Silicon Valley types. "
You didn't say the people who blog about Silicon valley (heck they may not even live here) you just said "Silicon Valley Types" which covers a lot of people, many of whom like the folks who founded Y-Combinator probably don't think of themselves a collective that "These character flaws are why we (the collective known as Silicon Valley) thought that a company with piss-poor revenues could IPO at an overpriced valuation, and have the same fan fare for over-valuation as it did in the valley. "
You impeach yourself by calling Facebook's revenue 'piss poor', it isn't, and then accuse "us", those who live in Silicon valley, with 'over valuing' when in fact that was the work of a collection of banks, based primarily in New York city.
I would love to hear passionate, pointed, editorial about how bankers and journalists unknowingly (or perhaps knowingly if you are the conspiracy type) in the creation of a value perception, but its a hard case to make here. There were literally years of trades in FB you could look at from SecondMarket, and there are a number of pretty cogently written analyses of their business model and the potential of their business. The Techcrunch whine about how it's not the bubble they were hoping for, and were so sure it was, will pass. And a lot of young people who weren't here for the dot com fiasco (or at least they weren't watching it closely) could learn from clear insights about what really makes a company worth a billion dollars to investors, or worth a hundred billion.
You could do that instead, start from what you care about and bring us along as readers, telling us why you care and perhaps educating us as to why we might want to care as well. That may or may not be effective, but it certainly would be less snarky I expect.
TechCrunch is entertainment, not analysis. Same goes for practically all financial media. Something tells me Warren Buffet does not watch CNBC.
Thanks Azat!