Being politically correct has never been my strongest quality; therefore I’ll say this: I don’t feel sorry for Facebook’s new shareholders. Despite NASDAQ technical glitches and analysts sharing changes in estimates for the near quarter only with big clients, the Facebook initial public offering (IPO) was a success.
Yes, a success.
See, the IPO market in the US is rigged. It is used by the big brokerage firms to butter up their best clients — the ones that bring them the most business — and not [necessarily] to benefit the shareholders of the IPO company. This is Wall Street at its worst. The underwriters are supposed to represent the interests of their client, the IPO company (in fact they get paid handsomely to do so) but there is a conflict between the one-time fee they receive from the IPO company (plus, maybe, the fees they receive if the post-IPO company decides to seek their advice in future M&A activity) and the very predictable trading commissions that are trickling in every single day from their large brokerage clients. To rig the IPO for the benefit of the brokerage clients, underwriters create an imbalance between supply and demand by keeping the offering price significantly below the level where supply/demand indicates it will open. That way, the best clients get to own the stock for a few minutes or maybe a few hours, the stock jumps 20 to 50 percent, and they flip it for an astronomical annualized internal rate of return (IRR).
I know it will be hard for me to elicit any pity for the company’s founders — the newly minted billionaires and multimillionaires — but it required risk taking, a lot of creativity, endless willpower, and sleepless nights to build a company out of nothing. Private-equity and angel investors will get even less sympathy from you, but they took a risk and bet on something nascent. We see and envy their successes; but we don’t see their failure, which happen a lot more often than we think. The speculators that add little economic value make these insane (usually almost guaranteed) returns at the expense of insiders.
Facebook’s IPO was a success because the insiders received full and fair value for their shares at the time of the IPO, though the stock did not go up 50 percent or double in a few hours after it went public. This is not a comment on Facebook’s valuation — I’ve addressed it before, and my view has not changed — but has to do with simple supply and demand for the stock at the time of the IPO. The Facebook CFO who is blamed for poor performance of the stock since the IPO is a hero and should be praised for forcing underwriters to raise the number of shares issued and increase the opening price.
I also don’t feel bad for speculators who were loading up on shares, hoping a bigger fool would come along and buy them at a higher price: sometimes when you look for a bigger fool you end up looking in the mirror. Investors who bought Facebook at IPO, the ones who believed that Facebook shares were undervalued for fundamental reasons, should now celebrate the stock’s lower price. If they loved it at $40, they should be ecstatic at being able to buy it for $29. Absolutely no news came out over the last few days, including changed estimates for this year’s revenue and earnings, that should have changed the fundamental value of Facebook. Investors were not buying Facebook on this year’s 100x earnings or 25x revenues — if they did, they were fools; they were buying because they believe Facebook will be an unstoppable force that will make a lot (A LOT) more money in the future.
I get a kick out of media ridiculing Mark Zuckerberg for the ‘audacity’ of eating burgers with his wife in Paris on their honeymoon, while his company is ‘in crisis.’ In Zuckerberg’s eyes nothing has changed, and he is right. He did not want to bring the company public, because he didn’t want the short-termism of Wall Street and the media impact on the way he runs the business. To Mark’s credit, he is a controlling shareholder and doesn’t care what earnings Facebook will deliver next quarter — he is building a lasting franchise.
The day of the Facebook IPO was the day of justice, the day when the Wall Street got (deservedly) screwed and a company was brought public at a fair price.
Musical Note: When my son Jonah was five, his Montessori daycare teacher asked me to make a compilation CD for the daycare kids to listen during the day. That was not an easy task. I wanted the kids to listen to something that would have a lasting impact, something that would picque their interest in classical music (or at least not turn it off), but not something primitive (no “Baby Mozart” type of cr*p). It took a lot of soul searching, but my solution was elegant and simple (I am still proud of it): I took the second movement from piano concertos by Rachmaninoff (2nd), Greig, Mozart (21st and 23rd ), Beethoven (5th), and Chopin (2nd). I’m not completely sure how and where it started (if you do know, please get in touch) but composers of the Classical (1750-1830) and Romantic (1830-WWI) periods wrote second movements of their piano concertos with a lot of melody and romanticism.
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email, click here or read his articles here.
Investment Management Associates Inc. is a value investing firm based in Denver, Colorado. Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.