The IPO of Facebook, at 100x earnings in the middle of a period of extreme financial stress has unleashed a cacophony of criticism. How quickly we forget the basics of finance, or is it that our industry is still home to too many that never grasped them anyway? Here are some guiding points:
1. The valuation was not pulled out of thin air, nor was it set through an entirely democratic bidding process (had it been, the final multiple would likely have been far higher). As is usually the case in IPOs, especially those of nascent industries with less obvious track records, the Facebook valuation was essentially negotiated with a small group of very large institutional investors. True, Facebook wanted the highest price possible, but the largest institutional investors also wanted returns. These two parties sat across from each other and negotiated what they thought was a reasonable valuation level.
2. The underwriter took risk, which is why they had to intervene to stabilise the stock in early trading.
3. The buyers took risk, because this is a nascent industry, there is no telling if the market will accept their idea of what a fair valuation is.
4. The sellers took risk likewise, because the market may ultimately decide that a fair valuation is far higher.
5. The share price is now 18% below IPO level. But it won’t stay there. Reasons for selling so far include: the technical failures of the Nasdaq in early hours, which mean that investors want to get out rather than risk being stuck; disappointment that the stock didn’t leap at the open; and overall market conditions.
6. It is no coincidence that the S&P Index doesn’t accept companies until they have established a stabilising history. New companies are often volatile.
The sharp fall in Facebook does not represent an IPO failure, only a disappointment for lazy speculators who hoped to make easy profits from a massive, risky and technically difficult share issuance. There is a reason that Facebook management has not responded publicly to what has happened: It is not so unusual, and thus far does not represent a failure of management or even the underwriter.
We will have to wait for the early trading to calm, and possibly for the company to prove its worth before we can judge the success or failure of Facebook’s IPO.
1. The valuation was not pulled out of thin air, nor was it set through an entirely democratic bidding process (had it been, the final multiple would likely have been far higher). As is usually the case in IPOs, especially those of nascent industries with less obvious track records, the Facebook valuation was essentially negotiated with a small group of very large institutional investors. True, Facebook wanted the highest price possible, but the largest institutional investors also wanted returns. These two parties sat across from each other and negotiated what they thought was a reasonable valuation level.
2. The underwriter took risk, which is why they had to intervene to stabilise the stock in early trading.
3. The buyers took risk, because this is a nascent industry, there is no telling if the market will accept their idea of what a fair valuation is.
4. The sellers took risk likewise, because the market may ultimately decide that a fair valuation is far higher.
5. The share price is now 18% below IPO level. But it won’t stay there. Reasons for selling so far include: the technical failures of the Nasdaq in early hours, which mean that investors want to get out rather than risk being stuck; disappointment that the stock didn’t leap at the open; and overall market conditions.
6. It is no coincidence that the S&P Index doesn’t accept companies until they have established a stabilising history. New companies are often volatile.
The sharp fall in Facebook does not represent an IPO failure, only a disappointment for lazy speculators who hoped to make easy profits from a massive, risky and technically difficult share issuance. There is a reason that Facebook management has not responded publicly to what has happened: It is not so unusual, and thus far does not represent a failure of management or even the underwriter.
We will have to wait for the early trading to calm, and possibly for the company to prove its worth before we can judge the success or failure of Facebook’s IPO.
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