Gustavo Ballvé on May 30th, 2012
Food for thought, Home, Investment Themes, Media, Mental models, Portfolio Management, Risk management, Signal or Noise, Tech

The Facebook imbroglio had all the elements of a Mexican (or Brazilian, I admit) soap opera: a build-up toward success, then unexpected twists and turns revealing involving falls-from-grace and perhaps even villains. We’re yet to see if there will be any bounce-backs and happy endings. However, the angry reaction to the “soap opera” from the “general audience” – in this case, retail investors who apparently went all-in for the story – still managed to surprise me. I discuss an article by Joe Nocera and another by Prof. Aswath Damodaran making some very interesting points.

First of all, not being Zuckerberg, Saverin or a selling investor, and not having studied the company enough, I didn’t really care about the IPO. Sure, you know by previous posts here that I am very interested in business models arising from “Web 2.0” and even “Web 3.0“, but I don’t think I can judge their “investability” with any degree of margin of safety.

A second disclaimer is that I am well aware that Nasdaq botched the early trading in the world’s most-hyped stock, which can’t have helped. I’m also aware of the allegations that a more cautious forecast for Facebook’s results was not as publicly and loudly discussed as their more positive factors. The technical snafu is a very serious fault, no doubt. Quite frankly the second one is questionable but, much more importantly, isn’t at all a surprise: banks favoring their large customers over retail investors isn’t exactly unheard of. Going into an IPO – scrap that, into whatever deal you do, ever – assuming that everyone will act according to pristine ethical standards is a key to disaster. Hell, assuming a conduct within legal limits is dangerous enough. Be prepared, assume the worst, and don’t let your success depend on other people’s ethics, especially when the balance of power is in their favor. Even discounting the obvious, “as old as mankind” conflicts of interest between sellers and buyers (CAVEAT EMPTOR, for God’s sake!), one would think that, after so many crises and frauds and scandals, people would be a little less trusting.

Another very important issue is the distinction between a “failed” and a “successful” IPO. As the article by Joe Nocera in the NYT argues, “failed” for whom? Facebook certainly thinks putting US$ 16 billion in the bank rather than 2/3 or even 1/2 of that is pretty cool. Investment banks’ preferred customers didn’t get a IPO-day pop? So sorry. It’s not guaranteed, it never is.

Another important issue concerns the seemingly defunct moral concept of “personal responsibility”. Even as an “uninterested party”, I’m still an investment analyst with 12 years of experience, so in the weeks leading up to Facebook’s IPO I read many articles claiming it was overvalued at the initial proposed range – and a fair share of articles saying it was cheap. All the while the IPO pricing range was going up, until finally it was revealed that Facebook would go public at $38 per share – and that they would issue even more shares than before. I couldn’t say then, and can’t say now, who is right between Prof. Damodaran (in the “overvalued” corner) and Steve Wozniak (in the “I’ll buy it at any price” corner). I can only imagine the thought processes in “Joe SixPack”‘s brain as he convinced himself that, of course, “I know that Facebook shares are a great place to park my hard-earned investment dollars”. Again, the future may prove him right, but I suspect he had no way of knowing it with reasonable confidence. But since the stock is going down, surely it’s a scam! How could he be wrong? He must have been tricked!

Finally, an issue that worries me immensely is the short-term culture that the IPO mania creates. The public is screaming bloody murder for not having made money yet – what, a full week after the IPO! On the one hand, this culture definitely helps the long-term oriented investors that – I hope – read this blog. We need every kind of market “agent” – long-term holders, speculators, IPO flippers – to create a diverse market with the volatility we need to have buying and selling opportunities. But if Facebook and other deals serve to reduce access to the market for the more “boring” companies, then it’s a problem for the economy as a whole.

On second thought… what am I worried about? So-called “investors” will forget these “lessons”, assuming there are any, in a few months (one year, tops). Then it will be back to normal.

By the way, did you hear that Pinterest is considering an IPO?

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