Facebook's Flop: Blame Eliot Spitzer and the Fairness Brigade
Less than a week after social media darling Facebook floated it shares to the public, regulators are already starting to sniff around a share offering seemingly gone awry. The 26% drop in the share price in our "everyone gets a trophy economy" surely made investigations inevitable, though the irony here is quite rich.
Indeed, it's fair to suggest that the seeds of Facebook's less than stellar IPO were planted in the early part of the new millennium, in the aftermath of the first Internet IPO boom. Facebook's allegedly jilted investors are to some degree reaping the false benefits of the hysteria that prevailed after the Internet bust of 2001.
It was then that the symbol that is Wall Street was under fire for the "insidery" nature of the industry's IPO practices. Specifically, only very rich retail investors and large institutional players got to participate in the offerings of once high-flying Internet companies, and as the first day run-up in the shares of some of these "new economy" wonders (remember The Globe.com?) was often substantial, the "spinning" of shares to preferred customers generated a lot of negative attention from politicians and journalists alike.
Missed at the time by Eliot Spitzer and other purveyors of "fairness" were some market realities easily understandable to those even fairly close (at the time I was at Goldman Sachs) to the IPO process. Share allocations that clearly favored the rich and big were surely the rule in the late ‘90s and early part of the ‘00s, and with good reason. As evidenced by how many public Internet firms eventually disappeared, IPO shares are the embodiment of risky investing. The investment banks that took Internet companies public back then naturally were criticized for their non-democratic allocations of shares that for a time seemingly only went up, but with politicians, journalists and regulators nothing if not hypocritical, once reality found its way to Internet share prices, they wanted blood for those same shares plummeting in value.
Of course that was the point of exclusive share allocations to begin with. Hard as it may be to imagine for some, shares were only allotted to the big and rich precisely because the capital markets teams at investment banks wanted shareholders to whom big spikes or declines in share prices were irrelevant. Yes, Wall Street was protecting the small investor. To put it very simply, if your material wellbeing was even remotely impacted by the first day moon shot in the allocated shares of companies like Amazon.com, then you weren't going to get an allocation.
The reason for this was twofold. For one, as has already been discussed, the Internet companies of the past were nothing if not risky, and the investment banks that brought the shares to the market did not want to suffer the complaints of countless small investors assuming share prices plummeted, as so many ultimately did.
Second, eager to oversee successful public offerings, capital markets teams wanted the shares in the hands of individuals who wouldn't sell them right away in order to bank short-term profits. Basically they wanted buy-and-hold investors, and those with means (as in rich) fit this description well. As for big institutions, in order for them to get big share allocations they would be asked (commanded really) to commit to buying a multiple of shares allocated to them once trading began.
In short, the allocation of shares back then was very scientific, and done with an eye toward a rising share price after the shares were floated. Big and rich investors were the ideal shareholders with the latter in mind, though as evidenced by the negative trajectory of so many Internet companies, investment banks couldn't credibly control the direction of share prices no matter their skill at allocation. Regarding the first-day spikes of certain Internet companies that bothered so many on the outside looking in, history tells us they were ephemeral to say the least, but certainly a good branding tool.
Considering Facebook, no doubt one major reason its shares didn't pop upward last Friday had to do with its brand already being so well established. Indeed, with Facebook having heavily saturated the global imagination well before going public, it would have made no sense for Morgan Stanley and the company's other underwriters to leave any money on the table in order to achieve a day-one price boost.
After that, it could credibly be argued that Facebook's offering was doomed either way for "sins" that took place when Mark Zuckerberg was still in high school. What's interesting in particular is that assuming Facebook's market cap had increased 26% since Friday rather than declined, it's arguable that regulators would still be sniffing around the offering.
That's the case because a pop in the shares would have signaled to government officials that the most democratic of companies (figure almost anyone can sign up for Facebook) was not so democratic about allocating its IPO shares. That IPOs were so exclusive way back when (thank goodness once again considering how many ultimately flopped) had the Eliot Spitzers of the world convulsed, so assuming a Facebook offering only enjoyed by a small elite, it's fair to say that this would have had today's ambitious politicians and regulators up in arms.
Perhaps sensing the above eventuality, Facebook's underwriters made the offering far more democratic than they should have, and evidence supporting this claim is the fact that the retail allocation was 25%. Quite unlike the IPOs of yesteryear that small investors were left out of, Facebook's included them en masse. Back in the late ‘90s rich clients were shut out of future IPOs if they sold their Internet shares on the first day of trading, but judging by the heavy selling since last Friday, it seems the mass of retail investors invited into the IPO were more difficult to control. Facebook's falling share price speaks to this lack of control.
It's often properly said that a fair economy is rather unfair, and the Facebook IPO is a shinning example of just that. Simply put, small investors got to participate alongside the rich and the institutional, and because they were allowed in, they're learning the hard way that investing in even the bluest of blue chips is very risky.
But make no mistake about how this came to pass, as it was rooted in silly notions about equality and fairness, and that markets should be open and democratic. Well, here's the painful tradeoff to democratic markets that Spitzer and the fairness brigade clamored for early in the new millennium. Facebook's sagging IPO is their limping reward, and another reminder that investing should be left to the pros; that, or those too rich to care about paper losses.