FB crashed through the $30 floor yesterday and may have some more room to fall. Having gone public at the unsupportable number of $38, it is down over 20%.
But the company did not betray investors. Neither did the stock market. Most IPOs fail. Many disappoint. Google, LinkedIn and Groupon, to name some other recent supernovas,, also crashed in the first month of trading. This is what IPOs do.
So let's be clear about what happened. A bunch of people made money. Early employees. Early investors. Big investors. Investment bankers and some institutional investors. They were rewarded for the risk they took and the effort they expended to create something phenomenal from an idea. That's actually pretty cool. That they did not share their largesse with you and the rest of the investing community? Dont say you werent warned.
A decision was made. Some might argue that it was cynical and selfish and the way it was handled was borderline immoral if not illegal. Everyone involved knew that the investing universe expected a 'pop,' on the first day of trading. The exponential increase in share price that the world came to expect in the glory days of the dotcom delusion. Why no one remembers that there have been a financial crisis and two recessions since then boggles the mind as one of them is the worst since the Great Depression. That pop in price is not guaranteed. It is not in the Constitution, the Bill of Rights or the Magna Carta. No economist on the ideological spectrum from von Mises to Keynes will weep - or draw a chart - in sympathy for those who thought this IPO was a sure thing.
The decision that the company's executives, board and bankers made was that the staff and early investors would get paid. Everyone else would have to take some risk and wait. That is why so many shares were offered and why the price was set so high. Those who had waited seven years since the company's founding wanted some reward. The warnings about the risk the IPO posed was manifest - not the least because of the frothy overhyping that started months in advance.
But as we have reported before, the history of IPO performance is available for all to see: and it is not pretty. Long on risk, short on reward. Consistently. Over decades. So yes, this was disappointing and deflating. The bankers who managed the offering have done additional damage to the already shaky foundations of the capital markets. Trading volume is down significantly since the crisis. People don't trust the markets or the market makers. And this event confirmed their fears. But this happened in plain sight. The markets have signaled that they intend to run by and for themselves and their favored clients. They have lobbied, testified, spoken, written and made vast political contributions to protect their option to do so. They are not hiding any of it. It is not about you. It is about them. Those who are serious about wanting it to change are also going to have to invest their time and treasure to do so. Just like the last week's winners did. JL
Chuck Jaffe reports in Marketwatch:
In the past few days, thanks to the initial public offering of Facebook, investors have learned what the letters IPO really stand for: “It’s probably overpriced.”
Truthfully, the initial public offering process is built and managed to give a predictable pop on opening day, which results in an equally predictable fallback later, which is why chasing after any initial public offering is the Stupid Investment of the Week.
Stupid Investment of the Week highlights the conditions and characteristics that make a security less than ideal for the average investor and is written in the hope that spotlighting danger in one situation will make it easier to sidestep trouble elsewhere.
Facebook actually was the Stupid Investment of the Week when it first registered its paperwork and planned on going public. It has actually lived up to that label since it went public Friday.
But the real issue here for investors is bigger, and it amounts to a slightly different concept: When Wall Street gets excited by something new, investors should get nervous.
The more buzz a new offering creates on the Street, the more individual investors get interested and excited and the easier it is for the guys behind these offerings to make money.
And that’s what an IPO is meant to do, fund the company and reward its founders, and make money for the people who are handling the deal.
If you’re an average investor, you’re not getting the first shares. Think of it as if it was the starting line for a big road race, where there’s a huge crowd of runners standing by the starting line ready to go … and you are part of the huge back that is queued up about a quarter-mile deep.
Even if you have the wherewithal to win the race—or at least pass a lot of the runners ahead of you—it is the guys upfront who have been promised a fast, easy start.
But continuing the analogy shows why investors really don’t want to take part in the IPO process anyway.
While there have been companies that have gone public and then gone private in fairly short order, the vast majority of companies that go public, stay public.
Thus, they’re running a marathon, and not a sprint. The Wall Street firms doing the deal and their favored investors, the ones who get to start the race at the front of the pack, can make short-term, quick-hit bets knowing that the rush behind them ensures their profits. The average guy buying in just after them is relying on “greater fool theory,” the idea that someone else will come in with even stronger emotions, willing to pay more.
Clearly, that didn’t happen with Facebook. For all of the buildup, there were plenty of naysayers out there talking about the company’s valuation. Charles Rotblut, editor of AAII Journal, said on my MoneyLife show that the stock would be attractive in the $20 or $21 range and that investors who missed out on the IPO would be better off waiting to see if the stock gets there than to buy in at a higher price just to be in early.
For everyone who points to other famous IPO pops and big-day openings as a reason to want to play initial-public offerings, they forget the truth in the numbers. If you waited three months to buy Google when it went public, for example, you were in roughly at the same price as when it first traded, and that means the front-of-the-pack price that the average guy couldn’t actually get on the first day.
But the more common examples show that after the manufacturer price pop disappears, new stocks often trend down. LinkedIn, for example, dropped about $30 per share—nearly one-third of its value—about a month after its IPO, and which was even lower five months out, before turning around and beginning a climb that now has it above the IPO level. Likewise, Groupon was off about 40% from the IPO price within a month of going public last fall, and while it popped back up for a time. It has yet to get back to the levels where it first traded and has been trending away from it.
In the 1980s, one of the first IPOs to capture public attention was for Home Shopping Network, largely because it made the company’s founders billionaires in a day, something that was unheard of at the time. I worked at the St. Petersburg Times, the local paper covering that deal, in an era before you could click on the Internet to make predictions on where a stock would go in the next day, week or month. I remember the reporters having a friendly wager on just where the stock would go from the surprising pop of the IPO. The winning bet was that the stock would go back to where it was first priced, then drop and only start to be fairly valued based on its fundamentals months down the road.
That’s how it has always been, and likely always will be.
Stocks start out trading on hype, but they end up being traded on their fundamental value.
Even if a stock were to go public at its fair-market value—something that never seems to happen—it’s probably not worth buying, simply because it’s no bargain, and it’s likely to get cheaper as the market adjusts and the hype fades and it ultimately settles in for the long run.
Hopefully that’s the lesson investors will take from Facebook; it won’t be the last IPO they talk about, but let’s hope it’s the last time the average investor is tempted to buy a hyped new stock right as it opens.