Is This Why Facebook's IPO Flopped?

Let's face it: Facebook's (Nasdaq: FB  ) IPO has now officially flopped. After shares popped for literally one minute on IPO day up to $45 only to close almost exactly at the offer price, shares promptly got crushed on Day 2 and have reached as low as $30.98 as of this writing on Day 3.

That's a loss of 9% at the low, and a solid 18% below the $38 offer price. That low also puts Facebook's market cap around $85 billion, or $19 billion less than the $104 billion valuation it fetched based on the offer price.

What gives?

Pick a reason. Any reason.
There are plenty of possible reasons Facebook has unimpressed investors, whether it be its lofty valuation, reliance on Zynga (Nasdaq: ZNGA  ) for payments revenue, concentrated voting power that Mark Zuckerberg controls, or the fact that it's not Google (Nasdaq: GOOG  ) when it comes to its advertising business.

Well, here's another reason that doesn't help: Lead underwriter Morgan Stanley (NYSE: MS  ) slashed its estimates heading into the historic IPO.

Ouch.

The good news
On one hand, this is actually good news. Not for Facebook, but as a positive sign that not all big banks are quite as evil as Goldman Sachs (NYSE: GS  ) , which also happened to be a major underwriter below Morgan Stanley. Big banks are required to have firewalls to separate their investment-banking divisions, sell-side analyst research departments, and proprietary trading desks, so that the inherent conflicts of interest within the businesses don't intermingle.

Say what you will about doubting whether or not these firewalls are implemented to full compliance (and I won't argue with you), but this move by Morgan Stanley actually affirms that its analysts really are trying to be objective, especially at a time when the bank should be talking up the deal.

The bad news
Morgan Stanley analyst Scott Devitt reduced his revenue forecasts during the investor roadshow ahead of the offering, which is odd considering Morgan Stanley's role. Devitt cut his second-quarter and full-year revenue estimates, largely because of Facebook's amended S-1 filed on May 9 that used gloomier language related to its mobile risk factor. It's unclear what his exact estimates were, but they were definitely lower.

Facebook believes its advertising revenue will be under pressure as users shift to mobile platforms that are largely non-monetized relative to its desktop platform. I say "gloomier" because Facebook was already rather gloomy on its mobile prospects, even in its first S-1.

For example, this is taken directly from its first S-1 filed on Feb. 1:

We had more than 425 million MAUs [monthly active users] who used Facebook mobile products in December 2011. We anticipate that the rate of growth in mobile users will continue to exceed the growth rate of our overall MAUs for the foreseeable future, in part due to our focus on developing mobile products to encourage mobile usage of Facebook. Although the substantial majority of our mobile users also access and engage with Facebook on personal computers where we display advertising, our users could decide to increasingly access our products primarily through mobile devices. We do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven. Accordingly, if users continue to increasingly access Facebook mobile products as a substitute for access through personal computers, and if we are unable to successfully implement monetization strategies for our mobile users, our revenue and financial results may be negatively affected.

Source: S-1 Registration Statement filed February 1. Emphasis added.

Facebook started displaying sponsored stories in mobile news feeds in March to begin trying to monetize mobile users, and the amended S-1 filed on May 9 really only updated some metrics for the first quarter and added one meaningful sentence within this particular risk factor:

We believe this increased usage of Facebook on mobile devices has contributed to the recent trend of our daily active users (DAUs) increasing more rapidly than the increase in the number of ads delivered.

Source: Amended S-1 Registration Statement filed May 9.

It also added this nugget to the risk factor on how Facebook prioritizes innovation and user engagement over short-term financial results:

As an example, we believe that the recent trend of our DAUs increasing more rapidly than the increase in the number of ads delivered has been due in part to certain pages having fewer ads per page as a result of these kinds of product decisions.

Source: Amended S-1 Registration Statement filed May 9.

So while the May 9 amendment that led to Devitt's reduced estimates spelled out Facebook's mobile risks a little more clearly, there wasn't really anything that we didn't already know.

The list grows
This update was supposedly disseminated to the bank's "major clients," one of which actually went ahead and bought shares in the IPO allocation, sold them immediately, and went short on the first day. One of the funds that received Morgan Stanley's update called the move particularly "unusual" for a book runner so close to the IPO.

We can now add this as another reason Facebook's IPO has been a disappointment for investors: Its lead underwriter bashed its prospects just days before the offer. Looks like that firewall is working after all.

Forget Facebook. Here's the Tech IPO You Should Be Buying -- it's a social networking company that competes with Facebook that has much better prospects for monetizing its user base. Grab a free copy of this report to read more.

Fool contributor Evan Niu holds no position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of Goldman Sachs and Google. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (3) | Recommend This Article (8)

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  • Report this Comment On May 22, 2012, at 9:32 PM, dallas797 wrote:

    Taking advantage for gaining trade during IPO and short it is the excellent way to get more $$$$$ with this stock since FB is just nothing to me, why would I invest long term with this guy...to hear ppl gossip and look at a lady who put cream on her face before bedtime? Or read other ppl stories that is a waste of time for this whole world. What is the potential of product really delivered by FB after all that make ppl believe in investing? to me a big ZERO!...FB is for kids...not for investment... My kids use it though...For $$$ I go elsewhere!

  • Report this Comment On May 23, 2012, at 3:12 AM, StockNewb wrote:

    facebook is useful I just dont think its a 100 billion, msybe 40-50 ;P

  • Report this Comment On May 23, 2012, at 12:16 PM, TooMuchFun2000 wrote:

    Facebook does have a product, but many people can’t wrap their heads around it: Their product is information and their market is advertisers. It’s a new paradigm. We’re use to looking at a product as something we can hold in our hand, but the world is changing. What has value in our new world is more nebulous, and if Facebook can manage the monetization of the information they have, their product will be very, very valuable…but that’s a big IF. With regard to selling short – it _is_ a great way to make money, especially if you know the stock is going to fail, and herein lies the problem. Some individuals invested with true risk, which of course, is their choice. But others may have had information (if the allegations are true) that gave them an advantage, AND hurt the stock for those that were willing to take some legitimate risk. It is probably reasonable to assume that if everybody had the same knowledge, fewer people would have invested. If the allegation _is_ true, then the stock _was_ manipulated and certain investors received an unfair advantage, which in effect, destroyed any opportunity for those in the dark to prosper.

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