As Facebook’s stock plunged below $30 on Tuesday, most of the commentary focused on the various errors of the company’s $16 billion initial public offering. It certainly has been a debacle for the investors who bought when the shares began trading on May 18 at $42, a $4 premium over the official offering price. Since then, the stock has fallen by almost a third. Beyond the consequences of this specific IPO, however, there’s the question of what it says about the outlook for stocks in general. Specifically, should investors see the wretched performance of Facebook’s IPO as a sort of signal about the future direction of the stock market and the economy?
Companies that are waiting to go public generally try to offer their shares when the market is riding high and they can get a good price. But other considerations influence the timing as well. Foreign companies that offer shares in the U.S. may be more concerned with conditions in their own countries. For example, as a result of a program of government restructuring and privatization in Germany, Deutsche Telekom made a $13 billion offering in 1996, more than three years before the U.S. market peaked. And some domestic offerings are made for strategic reasons. Cigarette maker Philip Morris (now Altria) decided to partially spin off Kraft in 2001, hoping to shield Kraft’s assets from ongoing tobacco litigation. Still, a lot of IPOs do take place close to market tops. Indeed, a stream of multibillion-dollar offerings were rushed out either just before the 1999-2000 market peak or immediately after. These include AT&T Wireless, UPS, Goldman Sachs, Charter Communications, MetLife and Agilent Technologies.
But while the scheduling of IPOs reflects more than simple market timing, there can be implications about the likely market outlook. To understand why, it helps to look at three key considerations for top executives who are planning a public offering:
1. Getting a generous price for the stock. Companies know what their shares are worth based on current results. Indeed, they can value their businesses far more accurately than outside analysts can because they have more-detailed information than is ever made public. And it usually makes sense to go public only if the company can sell its stock at prices higher than what the shares are currently worth. That doesn’t mean companies go public because they believe the market is at a peak and will soon turn down. (Apple went public in 1980, Amazon in 1997 and Google in 2004, all because they could get attractive prices — yet in all three cases, the stock market continued to rise for at least a couple of years.) But since stock-market booms tend to alternate with busts, companies often go public when the stock market is close to a top.
2. Selling before any bad news comes out. The value of a company’s shares depends not only on its current-year results but also on long-term-growth prospects. Insiders may want to proceed with an offering even in a less-than-ideal market if there is any risk that a company’s outlook may be impaired or will otherwise deteriorate in the future. Hospital-management company HCA Holdings went ahead with an offering last year, for example, because of a variety of uncertainties about health care reform and future tax policy. In such cases, an IPO may not be a direct reflection of the market outlook, but rather a response to great uncertainty.
3. Avoiding possible downturns in the economy. Any giant company contemplating an offering has access to world-class economic advice. The investment banks that advise potential sellers employ many of the world’s top economists and portfolio strategists. And because those institutions underwrite offerings for many companies and see their clients’ proprietary information, they have access to knowledge that would otherwise be unobtainable. There is no guarantee, of course, that advisers know where the stock market and the economy are going. But they have better information available than most investors do.
So what conclusions can we draw from the Facebook IPO, aside from the fact that the offering was overpriced? The company did overreach by increasing the number of shares to be sold and hiking the offering price by at least $3 in the days leading up to the IPO. But you have to wonder whether some sort of peak has been reached — if not for all stocks, then perhaps for tech, or even more specifically, for social media.
From a broader economic perspective, the Facebook IPO may also be a sign that Wall Street insiders see the growing risk of an economic slowdown later this year or next. That’s a reasonable concern, given that a majority of European countries are heading into recession, the odds of a major financial crisis in Europe keep rising and the Congressional Budget Office has forecast a likely U.S. recession in 2013 if a flurry of legislation isn’t passed in the next few months to avoid the so-called fiscal cliff (a combination of tax increases and spending cuts that are scheduled to go into effect next year). If Facebook’s advisers think such risks are a serious possibility, they would likely have told the company, “Either you do the public offering now, or you might have to wait three or four years.” Facebook obviously decided it was better to be safe than sorry — and that’s a bellwether worth taking seriously.
VIDEO: The Facebook IPO: Explainer