(Written for a local newspaper op-ed, but rejected)
More than seven thousand IPOs in the last thirty years have returned, on average, just under 18% on the first day itself. In the case of Facebook, this return was less than 1% (using the pre-IPO price of $38). It has also been shown that underwriters generally price IPOs conservatively, that is, below what they think will be the actual fair market value. They do this for two reasons: firstly, they are not completely sure how the market will react to the stock; secondly, pricing low means higher first-day returns, which is generally good for the company. Given these two facts, Facebook’s performance was exceptionally poor. So what happened? There are a couple of explanations.
The hype generated around this IPO was tremendous. There was a flood of information and analyses that existed before the stock went public through a variety of channels including Twitter, financial news sites, blogs and yes, even Facebook itself. Unlike IPOs of the earlier years (those that returned around 18%), investors seemed like they had enough information about what they were getting into. Because of this, the underwriters responded by raising the pre-IPO stock price. Perhaps this was a mistake. If they wanted to generate the high returns that history has seen from IPOs, they should have priced low, and the market would have responded by raising the price thus, generating larger returns.
Of course, now information has come to light that the underwriters did, indeed, price too high. In fact, they had two separate prices: a lower price for those “in the know,” and a higher price for the rest of us.
The second explanation of the stock’s performance has to do with boring fundamentals. Facebook is a one-trick pony. They have a large user base, and one that is fairly entrenched. They exploit that user base for its data, but other companies are known to do it better. In fact, just before they went public General Motors withdrew ten million of its advertising on Facebook. Perhaps it is time to Facebook to up its game, and begin to innovate internally. It is time to start thinking of unconventional, yet socially productive ways of monetizing its user base. Thus far, the site has only become more complicated, unwieldy and difficult to use. This is not sustainable in the long-term. Yes, it was a great idea at first, and they were successful at raising funds down the line, but what will they do in the future? This is not clear, and investors are making that clear through the stock price.
In the wake of recent financial events, and the increase in financial phenomena such as dark pools, the transparency of information in financial markets has come into question. While it has generated lukewarm returns, this IPO has been a resounding success story for market efficiency. Pre-IPO, public pressure corrected the underwriters’ ordinarily conservative pricing tactics; post-IPO, the investors showed they understood Facebook’s low-innovation culture. Both indicate that markets are transparent and they do work.
What about the future? History has shown that IPOs perform worse than the market over a period of three years after they appear on the market. Things do not seem bright for Facebook, unless they make some drastic changes. Until now, they just had to please a few investors, but in the future, they will have to keep the public happy. And that, as history has shown, is not always easy.