Those investors who flocked to get aboard Facebook’s meteoric rise in the first public stock sale must feel like shorn sheep. Amid the media blitz frenzy, the underwriters, founders and eager initial private investors obviously overvalued the stock; the May 17 liftoff at $38 a share fizzled.
Such are the vagaries of the capital market. Despite the wide popularity of the leader in social networking, there wasn’t enough meat on the bones to support a markup of stock price to 100 times earnings. Less anxious investors could see that and failed to buoy up the post-offering market price so those unlucky IPO buyers could reap the profits already earned by the founders and early private investors.
By now the disappointed first-day stockholders have found an excuse for their bad judgment and are suing the company officials and their underwriters for some sort of misrepresentation or botched stock offering. With the stock currently priced at half of its initial public offering in a mere three months, their claim might find some logic. But first those unhappy investors should take a course in how capitalism works.
In Facebook’s case, the new stock just kept dropping its value in a steady slide down to the current price of $19. Any experienced investor should have anticipated that an unripe company in the fickle high-tech world couldn’t possibly be worth more than 50 times earnings, which is where the stock price currently pauses.
Another gaffe by the underwriters for the IPO was allowing the short lockup period for initial investors. That means insiders and underwriters have limited holding periods to sell stock. Already in just three months, insiders are dumping the stock on the fragile market for Facebook. Historically, the founders and initial investors are prevented from selling their vast holdings for a six-month period, twice as long as Facebook’s lockup. That is a sensible market tool to allow the new stock to mature and to find its market value range.
Insiders began to divest their remaining holdings last week. A major dump on the market was by Peter Thiel, co-founder of PayPal and already a multimillionaire from his sale of that stock in 2002. Disposal of 72 percent of his remaining shares after the IPO nets him a tidy profit of $3.5 million on his original $500,000 invested in Facebook, according to Bloomberg News. That was at the $19 and $20 price.
Others will have similar rights to sell in coming months, which could flood the market with nearly 2 billion new shares, four and a half times the IPO shares sold on May 17. It’s like rats deserting a sinking ship. When insiders sell too soon, or too much, the public perceives that they don’t want to continue supporting the company. That’s not a good recommendation to a new investor for all those new shares being dumped.
So what do the angry IPO investors think happened? One claim is that Mark Zuckerberg, the company founder, and his management team failed to report a decline in advertising revenue in a timely way. Another accusation is against Nasdaq for the breakdown in processing orders on IPO day that also implicates Morgan Stanley, Facebook’s lead underwriter.
Court cases will amply examine these issues over the next few years; one columnist mused that legions of attorneys will make more money than the non-insider stockholders of Facebook.
Bloomberg News columnist William Cohan is concerned that investors fail to get the message that investing in IPOs is a fool’s game — they are only the grist for Wall Street’s selling machine. A cartel of Wall Street’s five or six largest firms controls new stock offerings, and they benefit only three of their constituents — banks, big institutional investors and the underwriters.
The small investor doesn’t make the list, Cohan notes. They exist only to provide a market after the insiders and Wall Street barons have skimmed off the profits. That’s not to say small investors didn’t make money on Google and even Apple after many years of stock price setbacks. But not every IPO is a big winner.
The lesson to be learned, according to Cohan, is that small investors should stay away from an IPO and let the Wall Street machinery break down. That’s an easy lesson in grasping the roots of capitalism.
Ford is a freelance writer located in San Diego. He can be reached at johnpatrick.ford@sddt.com.
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