Facebook Pt 2: A Wall Street Insider’s Perspective

Prior to the pricing of Facebook’s IPO, not one institutional investor I spoke with expected a successful offering. In fact, I had said on Fast Money that I would sell any shares I received as soon as I could.  I had a bet with a noted hedge fund manager on the size and pricing of the deal.  He had believed that it would price at the mid-point of the original range.  My bet was an increase in size and price; I won lunch.

Having been involved in the pricing of hundreds of deals during my time on the sell-side of Wall Street, I can tell you that kowtowing to FB management, hubris and greed led to a failed transaction.  Facebook may also be to blame for the  poor performance since it appears that they took a much more active role than most other issuers usually do during an IPO process.  I can tell you that it is unlikely that the other “lead” managers had anything to do with the mechanics of the offering since they rarely do; they are there in name only.

Morgan Stanley had a lot at stake; they likely won the lead mandate based upon their view on pricing and size as well as their distribution capabilities through retail, a sales force that GS doesn’t have.  MS was not going to be the lead manager of the first “hot” tech transaction, the largest ever tech IPO, not to upsize on price and size, nor were they going to lose the lead role to a competitor.  They focused on the front end, hoping the back end would take care of itself.  My guess is that they pitched FB a valuation higher than the other firms seeking the business whereas the right thing to do would have been to start the price lower and then walk it up into the original range.  This was their first fatal mistake since they left themselves no margin for error.  Not increasing the filing range would have been a mistake since it would have sent a negative message about demand, but increasing the size significantly was a much bigger misstep. But, hey, more shares and a higher price equate to more fees for the underwriter.  And , of course, a more hallowed place in the record books.

Institutional investors were uncomfortable with such a large retail component – it is usually the sign of a poorly accepted transaction although, in this situation, their participation was strategized into the process from the outset.  And with all the hype, institutions believed that if the deal went south, retail would panic and sell.  The news flow was also terrible: GM dropping, the ad model being questioned and constant commentary on valuation.  When I was involved in a transaction I almost always received calls from Portfolio Managers cautioning me on price and size; MS undoubtedly received these calls too but ignored them, as I often did.  Institutions nonetheless piled into the deal figuring that MS had to support the transaction with a long lasting syndicate bid.  A free put is nothing to turn down.  As such it didn’t take long for MS to eat away at the capital allocated to support the share price and my guess is that they first took a stand above the issuance price, realizing that if FB traded to issue, it would trade through it in a heartbeat.  But FB, being THE trophy deal of the millennium, used their weight to get MS to take a large discount in their fees.  As with a lot of items bought on sale, there is a reason why the price is low.  In this case, the attendant discount manifested itself in less capital in the syndicate bid.

So lots of blame to go around, hindsight being 20/20 except of course for the smarter, professional investor who had it pegged from the start.  Overhyped and overvalued.  The NASDAQ technology glitches – those were icing on the proverbial cake.

At the end of the day, a troubled start to life as a public company should not have a long lasting impact on its stock price.  That will be the result of its ability to execute on its business model and the valuation investors assign to the company.  On this, I have no opinion.

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