Last week week saw the greatly anticipated listing of Facebook (the most popular social networking firm) shares on NASDAQ. Unfortunately for many investors this was a great disappointment. This article analyses and simplifies the reasons behind the same. Let us start by understanding the term listing.
Q1) What does the word listing stand for?
Ans. The term listing means to get listed on a stock exchange. (Stock exchange is a place where shares are purchased and sold). Once a firm get listed on a stock exchange, its shares can be freely purchased and sold by investors. In this current case of Facebook, its shares are listed on NASDAQ, a stock exchange in the United States. Thus one can now buy and sell shares of Facebook on NASDAQ. Listing is the end process of IPO.
Q2) What does the term IPO stand for?
Ans. IPO stands for Initial Public Offer. It is a process by which a Company gets listed on a stock exchange. The IPO by Facebook had attracted a lot of attention as it is the third largest IPO ever in the United States after Visa Inc and General Motors. Facebook raised more than 16 billion dollars through this IPO. In fact the original demand from investors for Facebook’s shares was so strong that the IPO size was increased by about 25% than originally planned. Also the price band of the shares was increased due to the strong demand.
Q3) What is price band of a share?
Ans. In simple terms, price band essentially refers to the price range at which shares are issued in an IPO. Price band consists of floor price and ceiling price. The minimum price at which shares are issued is called the floor price, while the maximum price at which the shares are issued is called ceiling price. (This is logically as the reader would note that in a room, floor is always at the bottom while ceiling is always at the top). In case of Facebook, the initial price band planned was $28 – $ 35 per share. However due to strong demand, the price band was revised upwards to $ 34 – $38 per share. Finally the shares were issued at the ceiling price of 38 dollars per share giving Facebook a very rich valuation.
Q4) What was the valuation of Facebook?
Ans. This price of 38 dollars per share gave Facebook a stupendous valuation of 104 billion dollars. This valuation rivals the market value of internet power houses like Amazon. In fact it exceeds the combined value of Hewlett Packard Co and Dell Inc. To give the readers a perspective, this valuation is roughly 10% of the GDP of the whole of India and is more than the GDP of many African nations. Also this expected valuation is nearly twice the money Indians spent buying bread and cereals last year. Unfortunately it is these very high valuations which led to a debacle when Facebook shares started trading on NASDAQ.
Q5) What happened when Facebook shares started trading on NASDAQ?
Ans. As was mentioned earlier the shares of Facebook were issued at a price of 38 dollars per share. When the shares of Facebook started trading on NASDAQ on May 18, the prices of the shares started falling during the first day itself. In fact the price decreased to 34 dollars on May 21st and further fell to 31 dollars the next day. Thus within 3 to 4 days of start of trading, the stock decreased nearly by 18% leading to huge losses to investors who lost nearly 19 billion dollars.
Q6) What were the reasons for this rapid fall in Facebook’s share prices?
Ans. One of the main reasons as explained earlier was high valuations of the shares. Analysts also believe that the high number of shares issued (nearly 421 million shares) also contributed to the fall in prices. Investor appetite decreased once such high numbers of shares were issued. This led to there being hardly any buyers on Nasdaq for Facebook’s shares while there were many sellers. Technical problems at Nasdaq (an US Stock Exchange) further aggravated the fall in prices.
Q7) What were the technical problems at Nasdaq?
Ans. Opening of trading on Nasdaq was delayed by about 30 minutes due to technical glitches. Also orders were wrongly executed for 30 million shares. Due to these technical problems small investors suffered estimated losses of over 100 million dollars as they were unable to buy & sell Facebook shares at prices they wanted to. Blaming high volume of shares for all its technical problems Nasdaq has now set aside 13 million dollars towards legal liabilities. Another reason was the lower forecast for revenue growth made by Morgan Stanley the main banker to this issue.
Q8) Why did Morgan Stanley lower the revenue estimate of Facebook?
Ans. Morgan’s Stanley’s internet analyst Mr. Scott Devitt reduced the revenue forecasts for the company. This lowered forecast was totally unexpected and was made just before the end of the IPO process. This change in estimates came on the heels of Facebook’s filing of an amended prospectus in which the company expressed caution about revenue growth due to a rapid shift by users to mobile devices. It is to be noted that this is unprecedented and unexpected. Also it is unclear if Morgan Stanley told only its top clients about the revised lower view or spread the word more broadly. All in all this confusion led to a panic among some investors who tried to sell Facebook’s shares on listing.
Q9) Who are the main losers?
Ans. All the investors who purchased Facebook’s shares at 38 dollars are losers. Unfortunately again small retail investors who were allotted 25% of the total issue are one of the main losers. Retail investors have collectively lost about 600 million dollars as on date.
Q10) What is the future of Facebook’s shares?
Ans. Currently Morgan Stanley is trying to support the price at the listing price of 38 dollars by buying Facebook’s shares. Many analysts believe that Morgan Stanley is doing so to essentially to refute the allegation that it had overpriced the shares. However it remains to be seen how long they would support the share prices. The coming weeks will see a lot of action in Facebook’s shares. Meanwhile already two law suits have been filed in New York and California alleging that Facebook and its bankers have deliberately misled investors.
Synopsis of Article
- Facebook recently concluded its much hyped Initial Public Offering (IPO)
- Its shares were issued at 38 dollars per share and were to be listed on Nasdaq (an US Stock Exchange). This gave Facebook a rich valuation of 104 billion dollars.
- Share prices of Facebook decreased once trading commenced on Nasdaq. Investors suffered huge losses to the tune of 19%. Falling below the offer price so quickly is considered very disappointing for a newly listed stock.
- High valuations, high number of shares, technical glitches on Nasdaq and finally lower revenue forecasts are the main reasons for this fall. In fact many analysts believe that in case shares were issued at about 25 dollars per share, all investors would have gained.
- All Investors including retail investors who purchased the shares at 38 dollars per share have suffered heavily. Once again investors are attributing their losses to poor disclosures and greed of the bankers who managed Facebook’s issue.
- It is pertinent to note that all the bankers who managed Facebook’s issue have earned 176 million dollars in fees. Also all investors who purchased Facebook’s shares earlier at significantly lower prices have made money. This includes Goldman Sachs one of the bankers, which raised 235 million dollars after selling its Facebook shares at a valuation of more than twice the 50 billion levels at which the firm made its December 2010 investment. The funds that Goldman manages for its clients raised a further 855 million.
- At least 3 regulatory enquiries are underway and two class action legal suits have already been filed alleging that Facebook and investment bankers misled investors.
This article has been written by Dr. Anil Menon . Dr.Menon believes that Finance is Logic. He is of the firm opinion that everyone can understand and apply financial concepts. His previous articles and lecture videos are available at www.simplifiedfinance.net He can be contacted at [email protected]