Wednesday, June 6, 2012

The Trouble With Facebook

Slightly more than two weeks after it went public, Facebook shares closed yesterday at just under $26 a share, or -32% below where the deal was priced on May 18.

This is a debacle any way you look at it.

True, IPO's are typically priced to extract the maximum amount of capital for the company, but underwriters also try to get a little "juice" for investors as well.

For example, when Apple went public, it was met with a frenzied response, and the stock soared in value in the first days of trading.  Here's how one website describes it:

By late 1980, Apple Computer had been a private company for three years.  Apple’s partners decided to take their company to Wall Street and put Apple on the stock market, making it a publicly-held company. 

At the company’s Initial Public Offering (IPO) on December 12, 1980, Apple shares were offered to the general public at a price of $14 each.  At the opening bell, the stock was priced $22 and sold all 4.6 million shares within minutes.

Apple’s stock offering had generated more capital than Ford Motor’s had in 1956 and instantly created about 300 millionaires – more than any company in history up to that point. In its first day of trading Apple closed at $29, giving the company a market valuation of $1.778 billion.

The problem with the Facebook offering is not that the stock has not done well - after all, the market in general has been struggling in recent days - but rather investors have gotten the very strong impression that the general investing public has once again been played for a sap.

Remember that the Facebook was originally supposed to be priced at $28 a share.  Then, after the company hit the road and investor interest was near maniac levels, they raised the offering price to $38 a share.

In the meantime, however, there have been several reports that Facebook officials were quietly telling large institutional investors that sales and earnings had slowed in the second quarter as mobile advertising has not yet met expectations.

Thus the big institutional players backed away from the deal, and allowed the unknowing general public to buy shares at unsustainably high levels.

Now, it could still all work out - most Facebook shareholders have not yet sold, so the losses are still mostly on paper, as Ron Lieber pointed out in the New York Times last weekend:

But it is investors who may be making the biggest mistake by drawing all the wrong conclusions. Facebook’s I.P.O. was not a failure for Facebook, given the pile of money the company raised from willing buyers. Investors have lost nothing so far except on paper, save for those people who didn’t consider the fact that the stock might actually go down and then sold out of panic or because they felt somehow cheated when the thing didn’t pop. 

I think what really bothers me is the investors - who have become largely disillusioned with the stock market over the past decade - now have even more evidence to suggest that the market is a "rigged game", where only a few insiders make any real money.

Stocks in my opinion continue to be the only change that legitimate investors have to make any money in the next few years.  Government policies have pushed interest rates on bonds to multi-generational lows, and offer very little investment value.  Investors should be selling bonds in favor of stocks, but they're not.

But ugly episodes like the Facebook IPO give investors yet another reason to stay with bonds.

I have a suggestion as to how this could solved, which I will post tomorrow.