Facebook shares fell 11% on Monday, after Morgan Stanley and other Wall Street banks ceased to prop up the social network’s stock at Friday’s $38 offering price. Although the IPO was a big success for Facebook and its early investors and insiders — who sold $9 billion worth of shares that they had acquired at lower prices — the offering was a disappointment for many investors who clambered to get a piece of the most hyped IPO in nearly a decade. The IPO also revealed significant problems at Nasdaq, turning what should have been a triumphant offering into an embarrassing debacle. Here are four takeaways from Facebook’s rocky public debut.
1. Facebook’s bankers, led by Morgan Stanley, priced the offering too high. Last week, in the hype-fueled run-up to Facebook’s IPO, there were numerous reports about the intense demand for a slice of the social network. The IPO was oversubscribed, we were told, causing Facebook and its underwriters, led by Morgan Stanley, to raise the offering price from a low of $28 to $38 per share and also increase the number of shares sold. Many pundits — including financial analysts and journalists — predicted a large first-day pop, fueled by investor demand for one of the hottest offerings in years. (I predicted a $46 closing price, which was relatively conservative but still too high.)
(VIDEO: The Facebook IPO: Explainer)
It may be part of an underwriter’s responsibility to support an IPO at the offering price, but the fact that Morgan Stanley and its partners were forced to wage such an epic battle to do so in the final hour of trading on Friday indicates a pricing failure. Simply put, the artificial demand distorted the market — until Monday, when the shares tumbled 11%. With Morgan’s Stanley backstop gone, the market priced Facebook at a more authentic level, $34, or about $10 billion less by market capitalization than the offering price. “The underwriters completely screwed this up,” Wedbush analyst Michael Pachter told the Wall Street Journal. The offering “should have been half as big as it was, and it would have closed at $45.”
2. Facebook’s fundamental financial metrics still don’t support its current valuation. If Facebook was overvalued at $104 billion, it’s still overvalued at $93 billion. Even after Monday’s sell-off, Facebook investors are still betting on the hope of steep revenue and earnings growth over the next few years. With $1 billion in profit last year, Facebook has an extremely high price-to-earnings ratio of 93 to 1. Even if you stipulate strong earnings growth, the company’s forward-looking PE ratio is at least 40 t0 1, by former Wall Street analyst Henry Blodget’s most “aggressive” scenario. That makes Facebook much more expensive, on a forward-looking (2013) basis, than tech juggernauts like Apple (10 to 1) and Google (12 t0 1). Is it any wonder that Apple shares climbed nearly 6% on Monday, as investors chose its relative safety over Facebook? (Google shares climbed 2.3%).
Meanwhile, Facebook’s revenue growth is actually decelerating, and knotty questions remain about the company’s advertising business. Given the fact that Facebook CEO Mark Zuckerberg has made clear that he prioritizes the company’s idealistic social mission over profits, investors should be very wary of buying the stock, even at these reduced levels. Should Facebook’s stock price be even lower than $34 right now? We may have to wait a few quarters to get a better sense of the company’s revenue and earnings growth, in order to find out where this stock should be priced.
3. Nasdaq can’t be relied on to conduct the biggest IPOs. Nasdaq had lobbied aggressively to win the Facebook offering over its rival NYSE Euronext, but when the big day came, its systems performed poorly. Trading was delayed for 30 minutes on Friday because the exchange had trouble matching buy and sell orders. Trades for millions of shares were never confirmed, and some traders didn’t receive trade confirmation for hours — some not even until Monday morning. These snafus may have caused some investors to not trade any further, hurting the stock’s first-day performance. One trading executive called it “arguably the worst performance by an exchange on an IPO ever.”
One thing’s for sure: Nasdaq suffered a serious black eye at what should have been one of its proudest moments, as home to the most anticipated IPO in nearly a decade. “This was not our finest hour,” Robert Greifeld, chief executive of Nasdaq OMX Group, told reporters on Sunday. He blamed “poor design” in the exchange’s trading software — which is particularly ironic, given the exchange’s reputation as the preferred home of tech companies. Greifeld said the exchange was “humbly embarrassed.” The Securities and Exchange Commission is investigating the problems at Nasdaq, and its report, when issued, will no doubt lead to another round of hand wringing about the exchange’s poor performance.
4. Ordinary individual investors should stay away from heavily hyped IPOs like Facebook. It’s a sad testimony on the state of our capital markets that the public is best advised to stay away from the most anticipated initial public offerings. The whole point of such offerings is to allow companies to raise capital to grow their businesses, while giving investors the chance to own a slice of America’s most promising companies. Forget about day trading and stock picking, regular people should be able to get in on IPOs in a sensible fashion, through mutual or index funds.
But the truth is that Facebook’s valuation had grown so large — thanks to several huge venture-capital rounds totaling a record-breaking $2.2 billion — that by the time the offering reached the public, it was already overpriced. In other words, insiders (and others, like Goldman Sachs, which invested $500 million last year at a $50 billion valuation) bid up the company’s stock price, leaving little upside for public investors. “The I.P.O. system only works if it preserves a balance between public and private investors,” writes the New Yorker‘s John Cassidy. “If this balance is upended, and virtually all of the rewards are reserved for insiders, ordinary investors will refuse to play the game. A dearth of I.P.O.s would hurt insiders along with everybody else.”
It’s a shame that one of the most anticipated IPOs in recent memory was marred by a serious price miscalculation, not to mention woeful first-day trading execution. Some have argued that the lack of a huge first-day pop is a good thing — and in a sense it is, because regular investors could have lost a whole lot more than they did. And the mispriced IPO may cause bankers to be more conservative in the future. But the various problems with Facebook’s IPO reinforce some of the worst stereotypes about Wall Street: That it’s skewed toward insiders and top banks to the detriment of average Americans. That its systems have become too complex for even one of the top exchanges to manage properly. And that it’s driven by hype that often obscures real financials, injecting an additional level of risk into capital markets that may ultimately drive away potential investors.