Well, that didn’t take long.

It’s only been five days (and only three trading days) since Facebook’s IPO, but lawsuits and investigations are already underway.  So much for the honeymoon (literally).

This NY Times piece does a good job explaining some of the reasons why Facebook’s IPO has gone awry.  The Massachusetts secretary of state and FINRA have both launched investigations, and it sounds like the SEC won’t be too far behind.  

So what happened to Facebook?  This was an offering well over a year in the making, so why didn’t investors like it?

Facebook is a victim of its own success.  This was the largest social media IPO and the third largest IPO in US history.  Valuation is hard enough in established industries like car manufacturing or credit cards (Visa and GM were the only two larger IPOs).  But so much of Facebook’s value is based on the expectation that it will find new ways to make money with all the personal data it gathers.  In order to accurately price something, you need to really understand it, and Facebook is just too new for everyone to properly understand.  Similar issues afflicted Groupon’s IPO.  It’s not hard to find someone who thinks these stocks are wildly overpriced, and its even easier to find someone who thinks they’re outrageously cheap.  Multiply these problems by $16 billion or so, and you get a messy situation.

Moreover, because it’s Facebook, more retail investors wanted to participate than usual.  It’s generally assumed that retail investors are less stable than the pros (who, I should note, aren’t exactly Homo economicus themselves).  

The straw that broke this nervous camel’s back came in the form of revised revenue growth estimates a week before the offering.  It seems as though everyone reacted to this news a bit differently, and the result was a “pop”-less offering.

Then Facebook got screwed by some factors outside it’s control.  A computer blip caused NASDAQ to delay the opening trade by about 20 minutes.  That didn’t help calm an already nervous crowd of investors and underwriters.

Of course, none of that would excuse the allegations that some underwriters disclosed information to select clients rather than the public.  That’s a pretty basic no-no, and one that does no one any favors if the SEC catches wind of it. 

Still, it seems more likely that the real cause of all the calamity wasn’t fraud or something shady, but just the huge hype surrounding the IPO leading to an overinflated valuation.*  Remember: in business, people tend to get litigious when they lose money unexpectedly, regardless of whether any laws were broken.  If the opposite problem happened, and the stock price soared way above the initial offering, then early investors would be preparing lawsuits instead. 

And, as an addendum, before we feel too sorry for Mr. Zuckerberg, et. al., let’s remember that this IPO made more than one person a billionaire.  Facebook is swamped with more money than I would ever know what to do with (I guess that’s why I’m not a Fortune 100 CEO).  By any objective measurement, this was a success.  It’s only because the hype and expectations were greater than delivered that Facebook and its underwriters find themselves in this sticky legal situation.  But given how much money they made on the deal, don’t expect any of them to lose any sleep over these lawsuits anytime soon. 

 

*Also, it’s been 5 freakin’ days.  The revenues are down because more users are accessing Facebook on their smartphones, and the Facebook mobile app currently doesn’t feature ads (it also kind of sucks, but that’s neither here nor there).  Once Facebook starts incorporating ads into its mobile apps, revenues will recover, and the share price should along with them (they’ll also probably make the app suck less).