With the recent Facebook drama that has unfolded over the last two weeks, many are left scratching their heads and wondering, “What the fuck just happened?” Hundreds of millions of dollars were lost instantly in the hours of the delayed trading, not to mention the hypothetical loss of billions of dollars of those investors – big and small - who gambled on the fact that Facebook would live up to its far-fetched predictions.
But Facebook flopped – hard – and left a wake of destruction in its path. On CNBC’s Squawk Box, Knight Capital CEO Tom Joyce called it “arguably the worst performance by an exchange on an IPO ever.”
Now, how did all this happen? Why did the golden child of the startup boom – AKA Web 2.0 – fail so miserably? In fact, there is not any one answer. A combination of factors is what lead to Facebook’s IPO demise.
The Evaluation was Too High
While all news outlets sloppily raced to release a headline with the highest valuation possible next to Facebook’s moniker, they forgot one small detail: this is people’s money on the line. So while the public perception was elated by the mesmerizing numbers of $80, $92 and $108 billion dollars, no one ever stopped to ask, “What makes Facebook worth that much?”
This is a good question, and one not easily answered. The closest thing the public had to a financial report was a rumor of $600 million per year in profits solely from advertisements. How does this translate into a valuation ten times the company’s revenue? Well, Facebook also claimed potential add on corporations, like a phone platform, app store and a realigned business startup plan for advertisers and merchants.
This may all sound like platinum gold bells and whistles, but one red flag should pop up in your mind: Facebook has none of these business ventures yet. So they are really being valued on their hypothetical entry into markets they have absolutely zero experience in.
Mistakes Made by Issuers and NASDAQ
Unlike most commodities, like harvest wood in Brazil, mined Gold in Africa or over the counter commodities trades in New York, Facebook provides a service that around 900,000,000 people use. So unlike most other companies, the public felt a tangible connection to the company they have grown to love.
This is the most dangerous aspect of the Facebook IPO: everyone finds a personal connection to the technology; and likewise, everyone can afford a $42 stock price.
So when Facebook went public, many people who had never owned a stock before demanded its possession. The result was disastrous. NASDAQ failed to process thousands of orders, leaving a sales on the docket for minutes, sometimes even hours, before finally executing the sale at a different figure than what the stock broker had initially placed. Had these brokers known that their orders would be executed at these unexpected prices, they never would have placed them to begin with.
What is worse is that allegations are surfacing as to insider trading violations within Facebook and the big banks. Officials state Zuckerberg unloaded hoards of personal stock in an effort to save his net worth. Officials also claim banks like Morgan Stanley only warned their biggest investors to skip investing in a shaky Facebook stock.
Because of all the hype, Facebook defied traditional valuation methods. Its valuation included a hypothetical possibility (which should never happen), or rather a hypothetical question that, if answered, could bring Facebook big revenue. What was this hypothetical question that the valuation was based on? If/when will Facebook monetize its vast user base? Seems simple enough, right? Wrong. No one, including Facebook, has the answer to this question. It is absolutely ridiculous… Facebook’s only value comes from the possibility of monetizing its user base, and it should not have gone public until it figured that dilemma out.
“Facebook has had plenty of opportunities to monetize its vast user base. That’s not entirely a revelation; the company’s IPO valuation was heavily predicated on that assumption. But can it execute? And if so, how?”
So now, after having an understanding of these devastating events, lets examine the additional contributing factors that lead to the giant Facebook flop:
The Public Is Not As Dumb As Wall Street Thinks
There have been too many other tech startup “can’t miss” opportunities that whiffed big-time. The pubic has since learned from this. So when the media and Wall Street ignorantly assumed the country would buy Facebook’s stock at any given price per share, they were left dumfounded when the majority of people decided to wait until Facebook reached a more suitable price (like today’s…).
No One Has Excess Money To Throw Around
Small investors are nothing more than middle, upper middle, or upper class families that, due to the stunted economic rebound, are still struggling with mortgages, debts, and bills to pay. Regardless of what socio-economic class these small investors may belong to, everyone is experiencing these financial troubles. So how do they have extra funds to gamble on at a ridiculous IPO? Clearly, they don’t.
As for the larger investors, they avoided jumping on the Facebook IPO train because they were obviously well-informed on the details of how unrealistic Facebook’s valuation really was.
No one goes on Facebook to actually buy things
Contrary to the view of the experts evaluating Facebook, very few users actually use Facebook’s platform to make purchases. And if there are not purchases being made, then there will not be advertisements to display. This logical reasoning dismantles Facebook’s argument for where their value comes from and the stability of their revenue when in reality it’s the opposite. For example, GM backed out of its Facebook advertising program very publicly just days before the IPO.
Friends Aren’t Really “friends”
Most Facebook users’ friends are actually more like acquaintances, which is an important distinction when discussing marketing, influencing, creating buzz, etc. LinkedIn users, on the other hand, have connections that are far more accurate in terms of the relationship that the connections reflect. When Facebook contends that social networks will influence more buyers, investors look at their own networks … and they don’t buy the hype.
The Dubious Assumption About Facebook "friends"
Those that evaluated Facebook wrongfully assumed that the amount of friends a user has on Facebook reflects how much a user will engage in Facebook's platform. This could not be any further from the truth. And if friends don’t engage, a big piece of what makes the Facebook power matrix potentially so potent falls away. For any internet business, how much an individual user interacts and engages on the platform is critical to its value. And in the valuation of Facebook, it was dubiously assumed that having more Facebook friends meant that the user will interact more on the site, which any American Facebook user could tell you is not true.
Experts say that the characteristics that make the Facebook platform what it is aren’t the same ones that’ll launch “a million new millionaires.” Sure, the early investors who acquired stock options early in the game came out big winners. But precious little of that largesse turns out to be in the cards for the rest of the investors.
“We have been embarrassed and certainly we apologize to the industry,” was the statement that came out from the NASDAQ spokesman.
In fact, we have all been embarrassed. Investors who were tricked and lost tons money are embarrassed. Entrepreneurs involved in tech startups with actual value who now feel like Facebook’s IPO ruined the market opportunity for the rest of us are embarrassed. Zuckerberg and his team are absolutely embarrassed by this public spectacle that has changed the way people view Facebook. And lastly, the American people are embarrassed that a company we spend so much time interacting with and put some much faith in has flopped in horrible fashion.