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The Facebook Fiasco – Lessons To Be Learned
Malaysia Perspective | 21 June 2012
By: Predeeben Kannan
Articles (10) Profile

For millions of people all over the world, Facebook represents the true meaning of open unadulterated expression – the ability to communicate freely with friends and colleagues in the most interactive manner. Others see it as a movement tracker, business networking space, while some even see it as the ideal “get to know” or “dating” site. For a select few, Facebook represents the ultimate leisure activity and games room. Regardless of the varying perceptions it has on people around the world, it is generally accepted as the ideal free and uncensored communication network, which has emerged stronger and more significant compared to its peers such as Friendster, Myspace and many others.

In recent weeks, however, that perception seemed to have changed to a certain extent. The principal that Facebook stood for has now been challenged by the general public and retail investors alike. What the “powers that be” at Facebook failed to realise was, that by going public, it had to rise above its social networking space and show its true character and morals in a totally different arena of public perception – that of being a responsible corporate citizen.

On 17 May 2012, Facebook shares were offered for an initial public offering (IPO) at US$38 per share. It shot up to US$45 on the first part of the day’s trade, but then settled back to just US$38. – not an impressive beginning, by any reckoning. Over the next several days, he shares continued to decline, falling to US$28later to US$27.72 and to a low of US$25Ironically, the worst casualties were the “ordinary investors” or retail investors as they are better known, many of who were the reasons Facebook ws created for in the first place.

Writings On The “Facebook Wall”
In this article, what really happened to the Facebook IPO will be explained. Prior to the listing exercise, the management at Facebook decided to raise its offer price above the reasonable valuation given for its earnings and revenue, by agreeing to an IPO price of US$38, which was effectively more than 80 times its historical earnings. In theory, this was possible – but only if its future earnings were excellent and it had great “real value” to offer. However, in reality, its lead underwriter should have informed the management of Facebook, that with the depressed markets, it should have just gone for between 10 to 15 times its historical earnings instead.

No one is quite sure at the time of writing, what transpired between Facebook and its underwriters; specifically, Morgan Stanley. What we are told now is that Facebook continued to pursue the higher price, rightfully aware that its online advertising business was declining, with large companies such as General Motors already decided on removing their advertisement commitment to the social network due to “uncertain earnings/revenue potential”. There was also continued concern about the growing use of mobile devices such as smartphones, an area in which Facebook has admitted to being weak in and ha yet to develop a clear advertising and marketing strategy to compete for business dollars.

The second big “blunder” that Facebook made was to float an excessively large amount of shares in a sluggish market, the possibility of unhealthy future earnings. The company floated 421 million shares, valued at close to US$16 billion at the price mentioned earlier, making it the biggest ever technology company IPO in the US. The allocation for retail investors was a whopping 25 of the shares. This group of investors w in for a nasty surprise – a free fall of Facebook’s shares over the next few weeks, largely due to non-disclosure of key information to investors.

Retail investors were especially sore that both Goldman Sachs and Morgan Stanley had revised the projection for Facebook’s growth downwards ahead of the IPO, but failed to inform them, instead only releasing the information to a select group of “institutional” clients. This brought about utter chaos as investors began selling their portions, when the news about the revision was released several days later.

For institutional investors such as the banks that were involved in the IPO exercise, their client was Facebook and not the retail investors. Therefore, their main aim was to ensure that Facebook would be able to raise the maximum amount of money to boost its returns, rather than to inform retail investors that there was a “leak to fix”. So the fact that they exactly announc the downward revised numbers, did not shock most analysts.

Retail investors on the other hand ha little to go on before rushing to take up the offer. All they hadto guide them we few SEC (US Secngs and a few years of historical results. Compare this to the banks and their top clients, who had access to senior management nd a muh deeper knowledge of the business, and one gets the picture of how Faceook had tarnished its repuion in the eyf the “ordinary investors” or retail investor actual users of the social networking

As a result of this fiasco, Facebook as well as the investment banks that led the IPO are currently subjected to at least two shareholder lawsuits. The lawsuits allege that analysts at the large underwriting investment banks cut their financial forecasts for Facebook just before the IPO and told only a handful of clients.

Investors “Like” To Be Fed The Truth
For investors, the lesson to be learned from this fiasco is not to part their money based on just hype alone. They should understand the stock well and invest based on strong fundamentals. Although the mainstream media kept highlighting what a powerful phenomenon Facebook in the age of social networks, investors should have learnt from the destruction of the Dot.com bubble in the 1999-2000 period, that valuations of each stock need to be studied before investing in a particular company.

History has proven time and again that the tech arena is responsible for the creation of many successful e-companies and Internet revolutionaries that have hundreds of millions of followers but with very limited real capital to show. At the end, it is the business model of a company that matters most. In the case of Facebook, it is essentially a “technologyny” with a “revolutionary phenomenon in social networking”. Many were looking for quick profits and did not realise that without a proper business model, returns and future earnings cannot be correctly predicted.

Although Facebook clearly has its strengths as a successful technology company; it has become quite obvious that in recent years, most tech IPOs seem to highlight an augmented reality of future business. business and trade woulntric”, compad to prove the fundamentals that t the valuations similar to regular “brick and mortar” companies.

Furthermore, tech companies must ensure that they too act transparently and are precise with their disclosures. This is to ensure that the general public do not suffer from a misguided leap of faith about a company’s potential. The lessons of this fiasco shine clear as day. For Facebook, it has earned the company a big “thumbs down” from its core followers – the retail investing public.

Predeeben Kannan has more than 15 years senior level experience at various media organisations in Malaysia and Singapore. For more dialogue, please e-mail predeeben@gmail.com.

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