THE financial system may not be in great shape, but why dwell on it? Stocks are rising and I.P.O. euphoria is in the air.
Facebook last week gave Wall Street something it really likes: a rough blueprint for the biggest initial public offering of stock in tech history. Instant billionaires and millionaires are being minted — on paper, at least — and there are riches galore for anyone able to grab them. Greed in the market is rising, and for some seasoned investors, there is an uneasy sense they’ve read this script before.
“It’s like we’re finally emerging from nuclear winter for I.P.O.’s but we’ve forgotten our history,” said Harold Bradley, chief investment officer for the Kauffman Foundation and a former executive with the American Century mutual funds. “If we don’t start paying attention, we’ll be making the same stupid mistakes all over again.”
That history is long, colorful and consequential, dating at least to the founding of the Dutch East India Company in 1602 — an initial public offering that expanded global trading and led to the colonization of the American island where Wall Street is found.
At their best, I.P.O.’s embody creative elements of capitalism — specifically, market allocation of capital for productive uses, and transformation of private enterprises into public ones. But hot offerings often foster capitalism’s worst excesses — manias, bubbles and, ultimately, crashes, with exploitation of naïve investors.
We appear to be in an early stage in the I.P.O. cycle, says Jay Ritter, an I.P.O. expert at the University of Florida. Facebook’s apparent valuation is frothy but “possibly justifiable,” he said. “I wouldn’t say at this point that it’s a bubble price — but for this valuation to make sense, everything has to go well for the company for years to come.” Facebook is being valued as though it will replicate Google’s trajectory, he said. “That’s possible,” he observed, “but I’m not buying the stock.”
At this stage, Facebook’s offering has the formless allure of a lump of clay held by a sculptor who hasn’t revealed his intentions. Big unknowns like the stock’s offering price remain, and details like its $5 billion size can be revised. No wonder the S-1 filing — the document Facebook submitted to the Securities and Exchange Commission — is customarily called a “red herring.” Like an odorous morsel placed to distract pursuing dogs, it may be largely intended to buy the company and its underwriters time to pursue their own designs.
In its meteoric early growth, Facebook resembles several companies with transformative technology: Microsoft and Netscape, as well as Google. Each is unique, of course. In last week’s filing, Mark Zuckerberg, Facebook’s co-founder, C.E.O. and controlling owner, highlighted the “unique combination of reach, relevance, social context and engagement” that the social network provides its users — and makes available to advertisers for a tidy fee.
Facebook is also a platform for games like Farmville, from Zynga, and services like music offerings from Spotify. The document revealed that Zynga alone accounted for 12 percent of Facebook’s revenue last year. Zynga’s shares leapt nearly 17 percent the day after Facebook’s filing.
Thomas Vandeventer, manager of the Tocqueville Opportunity fund, has been buying restricted shares of Facebook on secondary markets over the last year and expects to keep buying when the initial offering occurs, presumably in several months. The deep engagement of Facebook’s users — the countless status updates, wall posts and “likes” that glue them to it — hasn’t been adequately appreciated by the market, or fully monetized, he says.
Facebook also has room to grow globally. All this is why he says Facebook, like Google, is “the kind of stock that you want to get in on early and hold for years to come.” T. Rowe Price and Fidelity funds hold shares, too.
There are skeptics. Karen North, director of the Annenberg Program on Online Communities at the University of Southern California, says many Facebook users are already repelled by what they view as the network’s creeping commercialization.
“There is a tension between the intimacy of the service and the efforts to monetize it,” she said. “It’s not obvious that Facebook will be able to keep growing its revenues exponentially.”
On the other hand, many of the Facebook faithful are likely to crave a stake. Google’s co-founders used an auction to put their shares into public hands, instead of letting Wall Street underwriters control distribution entirely. In last week’s filing, Mr. Zuckerberg gave no hint that he was contemplating such measures.
Still, Reena Aggarwal, a Georgetown University finance professor, says she expects innovation. “They could reserve some shares to be sold on a lottery on Facebook itself,” she said. “You’d expect something like that from a company like Facebook.”
William R. Hambrecht, who has pioneered I.P.O. auctions, says they “help put shares in the hands of individual investors who actually believe in a company and intend to stick with it.” Traditional distribution — with Wall Street underwriters allocating shares to favored clients — usually results in tremendous first-day turnover and profit-taking, Professor Ritter’s data shows.
From 1980 to 2009, average I.P.O.’s gained 18.1 percent on their first day — and only 21 percent in the subsequent three years, far less than the overall market. Unless you are lucky enough to get the opening price, I.P.O.’s usually aren’t a great deal.
Google has been a glaring exception. Its shares gained 18 percent the first day — and nearly 400 percent in the next three years, and they’ve kept rising. Facebook could be similarly successful, but Professor Aggarwal says she won’t buy unless she can get the opening price.
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