Facebook shares continue to plunge from their IPO price. They’ve now hit $27, which represents only 60 percent of the $45 high mark they briefly struck on the first day of trading, two weeks ago. Facebook’s market value now stands at $58 billion, which is barely more than the valuation that Goldman Sachs and other investors paid in a private round in January 2011—and is actually less than what a lot of private investors were paying for Facebook shares in the secondary market in the months leading up to the IPO.
In other words, the victims of Facebook’s disastrous IPO were not only the “mom and pop” retail investors who foolishly piled into the stock on the day it opened. They’re also the supposedly “sophisticated” investors who bought shares on private exchanges like Second Market over the past year.
Those sophisticated pros include GSV Capital, a publicly traded investment company that bought a bunch of shares at a $70 billion valuation in June 2011, when the move was seen as such a coup that GSV’s own stock price went up as a result.
By January of this year, private market investors were buying shares at a valuation of about $100 billion.
Whoever bought at that price has now lost almost half of their money.
Worse, this stock seems capable of going lower. Henry Blodget, a former Wall Street analyst turned tech blogger, estimates that a fair price for Facebook stock is somewhere between $16 and $24 per share.
But even that could be overly optimistic. The scary thing is, if Facebook shares carried the same price-earnings ratio that Apple and Google carry, the stock would trade in the single digits.
Supposedly Facebook is worth more because it’s a “growth stock.” But guess what? Apple is growing faster than Facebook, despite being 30 times its size.
So it’s no surprise that Facebook shares are dropping. What’s amazing is that they’re not dropping faster.
Meanwhile, the finger-pointing and recriminations continue over the way the IPO was handled. Clearly, Facebook and its lead underwriter, Morgan Stanley, priced the shares too high and flooded the market with too many of them.
Morgan Stanley blames the NASDAQ exchange, whose computers failed on the day of the IPO, sending buyers into a panic, which caused the share price to fall.
But another issue is that in the days leading up to the IPO, Facebook warned Wall Street analysts that its business had weakened in the second quarter.
The analysts warned some of their clients, who backed away from the deal. Everybody else remained in the dark and rushed into the IPO, only to get wiped out.
Morgan Stanley claims it followed the letter of the law.
Facebook, in off-the-record conversations, makes the same argument.
Lawsuits are flying. Market regulators and congressional committees are also looking into the offering.
Whether anyone broke the law remains to be seen. But the whole thing still stinks, and will no doubt give retail investors yet another reason to be wary of the stock market.
The real problem is that the entire IPO process is broken and needs to be radically reinvented, says William Hambrecht, CEO of WR Hambrecht + Co., a longtime investment banker who persuaded Google to use a “Dutch auction” to sell its shares to the public rather than the traditional IPO format.
The good thing about an auction is that it relieves bankers of the tricky chore of trying to figure out how to price the shares. In a traditional IPO, a banker like Morgan Stanley has to gauge demand from investors and try to get the best possible price for the shares of the company.
If the bankers guess too low, the shares get a big “pop” on opening day, which sounds great, but really that is money that the company left on the table.
Some argue that in the case of Facebook’s IPO, Morgan Stanley did a great job of getting Facebook the highest possible price for its shares. The IPO price was set at $38.
That’s good in the sense that Facebook raised a lot of money for itself and left none for investors. But nobody likes to see a stock go reeling downward as soon as it hits the market. It’s bad publicity, and creates the appearance that the company pulled a fast one on investors.
Using an auction may not be right for every company, but for Facebook it would have been a great idea, says Lise Buyer, a former Wall Street analyst and now CEO of Class V Group, a consultancy that advises companies that are trying to raise money through an IPO.
“This is why when you have a high-profile consumer brand name that will have tremendous enthusiasm among investors, the company is much better off doing an auction, like Google did,” Buyer says. “It’s just too hard to predict what’s going to happen when you have so many investors who aren’t regular investors.”
Fallout from the Facebook disaster is hurting other tech companies. Some are holding off on plans to do IPOs because of the Facebook fiasco. They include Kayak, an online travel broker, and VKontakte, a social-networking site in Russia.
The Facebook fiasco has cast a “chill” over Silicon Valley that will make it harder for private companies like Square to raise more venture funding at super-high valuations. Square was hoping that despite being unproven, profitless and generating relatively little revenue, it could be valued at $4 billion. Now maybe it can’t. Wah!
Facebook’s fall has also dragged down prices of some publicly traded tech companies, like Zynga. But there are still a lot of newly public tech companies carrying ridiculous nose-bleed valuations.
LinkedIn and Zillow sell at 137 times and 139 times this year’s projected earnings, respectively. Pandora and Yelp won’t have earnings this year, so you can’t calculate a price-earnings multiple based on that time period. But they are expected to make a profit in 2013. Pandora trades at 209 times its projected earnings for 2013. Yelp trades at 180 times its 2013 earnings.
There is no way in the world that those numbers make sense.
For comparison, Apple—arguably the greatest tech company of all time—trades at 12 times its projected fiscal year 2012 earnings and 11 times its projected fiscal year 2013 earnings.
Nevertheless, some people in Silicon Valley will tell you that the crazy valuations on these newly public companies make perfect sense. I would only point out that these are the same people who thought Facebook was worth $100 billion, and now its value has fallen to almost half that much.
In the case of Facebook, investors in the public markets are finally showing some sense and not falling for the hype from Silicon Valley. But how long until the public markets apply this same cruel logic to the other overpriced stocks that venture capitalists and investment bankers have foisted upon them? How long until public investors get tired of playing the “greater fool” to the hustlers in Silicon Valley?
Not long, I’d bet.
As they say in Game of Thrones: winter is coming.
