May 25th, 2012 @ // No Comments
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If you read my piece last week about the Facebook initial public offering of stock, and you’ve read the news this week about the social network and others associated with the IPO getting slapped with class-action lawsuits and investigations, you know why I’m not a stockbroker. What happened? The stock dropped, and many smaller investors lost money – because they did not receive the guidance from Facebook that large institutional investors did, according to the charges.
What happened with Facebook’s IPO was unprecedented, not because of the size of the offering (though it was certainly the largest ever offered), but because of some questionable matters concerning who knew what, and when, and what they did as a result. Henry Blodget gives an excellent rundown of the events. It’s particularly helpful for those of us who aren’t familiar with the conventional industry practices surrounding IPOs, and therefore might not realize just how far Facebook’s IPO deviated from that standard.
So what happened, exactly? Facebook held what is known as the IPO roadshow to drum up interest in the stock. In the middle of that roadshow, the analysts at Facebook’s IPO underwriters cut their estimates for how the company would perform in its second quarter. This event is so unusual that at least a couple of long-time observers wrote that they had literally never heard of it happening before. Why did they cut their estimates? According to the lawsuits, someone at Facebook verbally told them to. But the worst part of it was that these cuts in estimates did NOT get shared with everyone.
Apparently, Facebook expected a weak second quarter. But why? We got a hint as early as May 9, when Facebook made a change to its S-1 filing with the SEC. In the revision, Facebook noted that many more users are accessing its website through mobile devices. This in turn reduced what the social network could charge for ads, which hits the company right in the long-term bottom line.
Here’s the money quote from the filing: “We believe this increased usage of Facebook on mobile devices has contributed to the recent trend of our daily active users (DAUs) increasing more rapidly than the increase in the number of ads delivered. If users increasingly access Facebook mobile products as a substitute for access through personal computers, and if we are unable to successfully implement monetization strategies for our mobile users, or if we incur excessive expenses in this effort, our financial performance and ability to grow revenue would be negatively affected.”
Now any investor who knows about this might take warning from it. The lawsuits allege that Facebook specifically told their underwriter investors to reduce their estimates for Facebook’s second quarter – and didn’t tell anyone else. Blodget explained that “The information about the estimate cut was then verbally conveyed to sophisticated institutional investors who were considering buying Facebook stock, but not to smaller investors.” This adds a whole new perspective to the increases in the amount of Facebook stock that large investors decided to sell when the social network raised the target price of its IPO.