The pitfalls of the Facebook IPO
Start-up companies generally get their money from two sources: professional venture investors and, a few years down the road, stock market investors.
What’s the difference? Here’s how one of the smartest high-tech entrepreneurs I know puts it:
“Venture money is expensive money, but it’s smart money. Stock market money is cheap money, but it’s dumb money.”
Facebook is about to cannonball itself into a vast pool of dumb money.
The big social media company is expected to announce its initial public offering as soon as Wednesday. The news will feed a frenzy over the profit potential of its marvelous business (self-described), inspire reams of ruminations about the new paradigms of communication and “friendship” in the modern socially interconnected world, foster profiles by the trainload of the scruffy new billionaires touched with pixie dust.
Actually, anticipation of the announcement has done all that. The deal is already being touted as a once-in-a-generation IPO.
But let’s take a breath and ponder what lies in store for all that dumb money.
First, the investors. There’s been a lot of talk about whether, or how, Facebook will keep faith with its hundreds of millions of loyal users by letting them in on the IPO. Can we get real? The best way Facebook could protect its ordinary users is by not letting them anywhere near this IPO.
For one thing, given the turbocharged excitement surrounding the coming deal, the likelihood is much greater that the shares will be fully valued than that they’ll harbor hidden treasure. It won’t be long before the holders of insider shares, including current and departed employees, will be able to cash out, diluting the market price further.
It’s possible that Facebook will insist that some retail investors be given entree into the IPO, but since the deal is expected to be managed by Morgan Stanley, with Goldman Sachs sniffing around on the periphery, there’s no chance that the opportunity will be anything other than window dressing. Yes, it’s conceivable that Facebook shares will open at, say, $100, soar to $500 in a year, or a month, or a day, and never look back. But that’s not the way to bet.
Consider the last once-in-a-generation IPO, which occurred all of eight years ago. That was the Google IPO, and yes, if you got in at the opening price of $85 a share and held on, you’ve made an average annual return of 40% on it.
But you didn’t get in at the opening price. Maybe you got in a year and a half later, when the Google aura was still strong and it hit $466 or so. From then to now, you’ve only made 4.73% a year. That’s not nothing, and it’s a couple of percentage points better than the stock market as a whole (measured by the Standard & Poor’s 500), but you could have done about as well by investing in 10-year U.S. Treasury bonds, which are risk-free.
And if you bought at Google’s all-time high of just over $740 (in November 2007), you’ve taken a bath — negative 5.72% per year, much worse than the S&P.
It’s rare that a company can live up to hype of the intensity swirling around Facebook, but not so rare for a deal to take place amid such hype. Yahoo, which was sort of a Facebook of its era, made more than 30% for its initial investors on its very first day of trading in April 1996. The stock hit a stratospheric price-to-earnings multiple of 125 in January 2000. Today its P/E is below 19 and the hype is all about whether it will survive at all.
Time and the unforeseeable march of technology have ways of taking the shine off even the most lustrous corporation. Microsoft? Once the occupant of such commanding heights that it was known as the “evil empire,” today it’s spoken of in terms more appropriate to the Grand Duchy of Fenwick. Apple was the apple of everyone’s eye at the time of its IPO in 1980, which was the biggest such deal in 24 years (after Ford’s). It’s the apple of everyone’s eye today. But between those two data points came at least one near-death experience.
Public ownership has a way of changing a company, not least because every misstep occurs under the eyes of that dumb money, along with the public markets’ humorless federal and state regulators. As a public company Google has had a lot harder time not being evil, to paraphrase its motto, than it did as a venture-funded start-up. As a public corporation Facebook won’t get away with the same shenanigans it has used to feed the hype thus far, and that may give investors a different slant on its profit potential.
More than one year ago, the indispensable market blogger Barry Ritholtz posted “5 questions for Facebook investors.” They’re still germane: How many of its hundreds of millions of users are active, posting at least once or twice a week? How long does the average user stay active? How many subscribers does it lose for every 100 it signs up? What’s it’s revenue per user? And where will future growth come from?
All of this will have to show up in some way in the company’s public registration statement, through which its claims of fabulous growth and profitability will be exposed to detailed scrutiny. Maybe it will look even better than the hype. But maybe it will be one of those things that makes you go, “Hmmm.”
Certainly the company’s approach to user privacy, which long has been twerpesque, will no longer wash. Founder and CEO Mark Zuckerberg’s serial non-apology apologies for its serial violations of privacy standards (“we really messed up,” “we moved too fast,” blah blah blah) have occasioned wry commentary, but the violations are no laughing matter. To the extent Facebook is thwarted in its attempts to monetize its user base by flouting privacy rules and conventions, the pushback by regulators, members of Congress and users will show up in its stock price.
Perhaps Facebook will be that rare company that misses all these potholes. You want to take that wager? Go ahead, if you can. But a year or two from now, we’ll see if the results have you shouting, “Yahoo!”
Michael Hiltzik’s column appears Sundays and Wednesdays. Reach him at mhiltzik@latimes.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.
