My colleague Eric Bleeker wrote a great piece last week telling the story of Facebook's (Nasdaq: FB ) bungled initial public offering. After shares plunged from their offering price, investors learned that Wall Street analysts cut Facebook's revenue estimates before the IPO after speaking with the company's management, and only shared the updated figures with well-heeled clients. Mom-and-pop investors are now outraged, suing nearly everyone involved. It's a big story. Eric's piece may go down as one of the most popular Motley Fool articles ever published.
I've thought a lot about the situation this weekend, and the more I look into it, the more I'm convinced that there's another angle here.
Most of the ire stems from the idea that, behind the scenes, Wall Street had a different view about Facebook's growth than it was telling Main Street. But Scott Devitt, the Morgan Stanley (NYSE: MS ) analyst in question who cut Facebook's revenue forecast before the IPO, is one of more than 10 high-profile Wall Street analysts covering the company. At least one other analyst covering Facebook has a price target of $48 a share -- some 50% above current prices. Why the fuss over Devitt's downgrade, but no attention to the still-bullish analyst estimates?
There's also lingering outrage over the impression that Devitt was part of the banking team touting Facebook shares to the public. But that doesn't appear to be the case. As Reuters explained, "Investment bank analysts ... are required to operate independently of the bankers and salesmen who are marketing stocks. That was stipulated in a settlement by major banks with regulators following a scandal over tainted stock research during the dot-com boom."
More important is whether Facebook management whispered material information to select analysts. As far as I can tell, we really have no idea what Facebook management said to Morgan Stanley analysts. Did they provide revenue projections that constituted inside information? I don't know. There's no record. Did they simply point to publicly available information when Devitt mentioned his estimates? No clue. Most articles analyzing the situation (there are hundreds) navigate with speculation and assumption, yet conclude with conviction that there was unethical conduct, if not fraud.
Here's what we do know. Weeks before the IPO, Facebook disclosed publicly that its mobile business could hurt revenue growth -- the same story Wall Street analysts allegedly had an inside scoop on. The company's amended filing stated clearly (emphasis mine):
Growth in use of Facebook through our mobile products, where our ability to monetize is unproven, as a substitute for use on personal computers may negatively affect our revenue and financial results ... we anticipate that the rate of growth in mobile usage will exceed the growth in usage through personal computers for the foreseeable future. ... However, 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 ... if we are unable to successfully implement monetization strategies for our mobile users, or if we incur excessive expenses in this effort, our financial performance and ability to grow revenue would be negatively affected.
This wasn't an obscure footnote that no one picked up on. "Watch out, investors: Facebook says mobile users could hurt revenue," VentureBeat reported more than a week before the IPO. "Facebook Says, Lower Your Expectations About Mobile," wrote The New York Times. Which is exactly, it seems, what Devitt did.
What's more, The Wall Street Journal reported before the IPO that General Motors (NYSE: GM ) was discontinuing its advertising with Facebook because the ads were ineffective. "GM's decision raises questions about the ability of Facebook to sustain the 88% revenue growth achieved in 2011," wrote the Journal. That was two full days before the offering.
It didn't seem to make a difference. Investors still lined up in gleeful anticipation to pay 100 times earnings for IPO shares. The rationale, by most accounts, was simple: It was widely assumed that shares would enjoy a substantial first-day pop, nurturing dreams of easy money. "You could write that Facebook was the worst company in the world, and retail would still want the stock," one broker told the Financial Times two days before the offering.
And put Devitt's downgrade in perspective: He cut Facebook's second-quarter revenue forecast by $64 million. For a company being valued at more than $100 billion, it would be generous to call that a rounding error.
If it turns out that anyone involved in the IPO process acted on inside information or violated securities laws, that's terrible, and those involved should be brought to justice. But as far as I can tell, there's no evidence of that yet. And rushing to judgment is one of the worst things an investor can do in a field that requires a cool, calm head.
Eric's article is a must-read because it drives home the point that banks aren't on individual investors' side, and that we should learn how to take control over our finances and make decisions for ourselves. That's excellent advice.
But I'm not sure Facebook's IPO changes anything that we didn't already know. It did, however, reinforce a timeless irony: Investors love speculation but hate losses.