

The market doesn't care about your overpriced valuation (Failbook) - wkasel
http://williamkasel.posterous.com/facebooks-failbook-ipo-or-how-silicon-valley

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robbiep
I feel like this article misses a number of points. Firstly, the modern IPO is
chiefly about giving early investors and staff an exit ticket. It is therefore
in their interests to price it as high as possible. The fact that there was
significant hype around the business meant that they were able to achieve this
valuation. The fact that this is distinct from the original aim of the
sharemarket - that is, capitalising firms to create new ventures (Think
infrastructure - the golden age of rail, factories, etc) is an interesting
side-note.

Secondly, the marketplace often operates on the stupidity of the masses.
Intelligent fund managers stay away from overpriced IPOs, the uninformed
masses pile in because they hear the hype and are not value investors so don't
know/care that the revenues aren't behind the company.

3- A successful IPO is one that is fully capitalised and gives the company new
cash. It is not one that goes through the roof. This would represent a failure
of the Merchant Bank to properly capitalise on the company's value (They could
have charged a higher value for the IPO as that would have better represented
the fair value of the company) \- in fact, in a perfectly valued company it
should track mostly flat as the investor return is priced into the dividend +
some accumulation of value.

The Facebook float, and the Zynga float, and numerous others, thus represents
a good example of management and investment banks fully capitalising on the
hype surrounding them to extract maximum returns for the early investors. The
fact that this screws later investors is secondary.

~~~
wkasel
With all due respect, I completely disagree. If you understand the
fundamentals of an IPO, as I explained below you would know that there is a
180 day lock-up period for employees, this means that employees haven't been
able to sell their stock yet. When they do sell their stock it will be at
$10/$15/share. The only folks who made money on the IPO were Merrill Lynch who
SHORTED IT!

You're typically supposed to IPO at the point you are preparing to grow. Not
flatline. Your original argument is exactly what I'm saying is the misguided
philosophy of Silicon Valley, and the Tech Community as a whole. Again, no
offense, but step back and look at what I just said. I have a point. This IPO
fucked everyone, including Zuckerberg, employees, and anyone else who still
holds shares which as I said above is every single employee.

~~~
epistasis
No, that's wrong, the only way an initial overvaluation hurts pre-IPO
investors is if the stock gets delisted, or the market is so offended that it
starts caring and undervalues the company. Otherwise, employees are just fine;
Since the market doesn't care, it gives them fair value when they have a
chance to sell. They lose out on cashing out during the over-valuation period,
but that was just free money for those that pulled the strings, pre-IPO
investors and Facebook management that could sell at IPO

The _only_ people hurt by the initial overvaluation were the people that
bought high. _Everybody_ else wins or is neutral. Everybody. Again, unless the
market starts caring about retribution and undervalues them. Otherwise
everybody gets exactly what the market will give them.

The ibanks, Zuckerburg, and initial investors that sold on IPO day or shortly
after, all win by a huge margin. They pulled the wool over lots of people's
eyes; perhaps not intentionally, perhaps they honestly believed their own
bullshit, but in any case their irrational exuberance hurt them not one bit.

~~~
jussij
> but that was just free money

Except the employees would have been sacrificing a higher salary for these
shares so they where hardly free.

> The only people hurt by the initial over valuation were the people that
> bought high

The people that got burnt where those that read the IPO document and assumed
it was not a work of fiction. The people that made money where insider trading
on information not yet public.

The others that will get hurt are the next set of companies that try to float.
The market will be reluctant to make the same mistake again.

Bad IPOs damage the credibility of the market and dmaage the ability of
companies to float and that Facebook IPO was just a joke.

~~~
robbiep
Your post kind of suggests that this was the first major company to ever be
overcapitalised and incorrectly valued. This is patently not the case. The
people that bought into the FB IPO did so out of their own free will. That
they believed the valuations is down to the hype surrounding the FBIPO and the
hard work of the underwriters to convince investors of the strength of their
case. There are 2 types of investors, informed and uninformed. These were
uninformed investors. They operate under the principle that they can exceed
the average market return (i.e. they don't understand the efficient markets
hypothesis).

The market doesn't make these mistakes, the investors do. The market is the
mechanism by which mistakes in valuation are discovered, as the IPO trends
towards its fair value.

The fact that these are bad for the credibility of the market does not deter
wall street for looking out for more sources of revenue (in the form of
underwriting IPOs). It may make companies thinking of raising cash on the
market think again - ('Is our valuation correct? How can we avoid being
overhyped?') but in the long run this is nothing different to what has
happened in hundreds of IPOs in hundreds of stock markets in hundreds of
companies over the past several hundred years.

~~~
josephlord
It is quite possible to understand the efficient market hypothesis and not
believe it. In fact I think that everyone who invests in the market in forms
other than tracker funds doesn't believe it holds.

The efficient market hypothesis is a useful thought experiment but the
assumptions required for its proof are unrealistic and it doesn't explain real
world volatility.

I do think the thought process of 'what do I know that the market hasn't taken
into account yet' is a useful one and that if the answer is nothing buy a
tracker. The knowledge could be proper research that disagrees with the media
about a company.

~~~
robbiep
I like and agree with your point

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goodcanadian
My only comment is that if you can make an overpriced IPO, that is good for
you. It is bad for the suckers who were dumb enough to buy in, but that is a
different story. If the share price goes up quickly after an IPO, the price
was too low. If the price goes down quickly, it was too high, but why should
you care? If you want to pay me $1.50 to buy $1 bills, I will sell as many as
you will take. The current market valuation only really matters when you want
to trade. Otherwise, worrying about your stock price is a bit of a pissing
contest. BTW, I did not buy Facebook or Zynga. They were both pretty obviously
over-hyped and overpriced (it seems most IPOs in most industries are), but the
stock holders prior to the IPO made out like bandits during the IPO.

~~~
wkasel
Logical explanation, however the point of an IPO is not just liquidity in for
your employees, but also to raise money for the company, and allow the public
to buy in. If you don't price it so the price goes up, then you're doing
everyone, even your shareholders a dis-service because they have a 180 day
lockup period, so when the stock is at $15/share at the end of lockup, you
actually screwed employees as well. The only person who actually made money on
this was Merrill Lynch.

~~~
wkasel
Fair, but the only problem I see with your reasoning is stock grants were
being issued as far back as 18 months ago at $25/share, which means that those
employees DID lose money.

~~~
robryan
That is the same though as investors buying in at $38. Employees could always
choose to negotiate the grants or leave if they think they are bad value.

~~~
wkasel
The root of my argument though is that as Silicon Valley know-it-alls we
assumed the world would gawk in awe of our amazing creation and throw money at
us, which it did not. It's a shame you can't buy put's on that, because THAT
would have been worth it. :)

~~~
epistasis
People did gawk at the amazing creation and throw money at Facebook
needlessly, and that's the problem. In a way, Facebook has been able to do a
bit of market segmentation, and take the initial money from those that thought
that it had the most value, without having to listen to the dissenting voices
that think it's worth less. Typically, markets prevent such a great
information disparity.

Before IPO, nobody knows for sure what the real valuation of Facebook is. They
have their own personal valuation, but the eventual price on the market is
going to be a reflection of the combined valuations, it's an average of sorts
of everbody's belief about Facebook's ability to make money over the time
scale that each particular investor cares about. You can make a price-demand
curve out of it; pre-IPO I wouldn't have bought Facebook at any price, some
people thought $15 per share, some people $20, some people $38, and some would
have bought no matter what.

Facebook was unique in being able to take advantage of this market
uncertainty, namely each investor's uncertainty about what everybody else
thinks. They shielded the overoptimistic from the pessimists' views, or the
overoptimistic didn't bother to acknowledge that there would be pessimists,
and Facebook took the optimists' money first. In doing so they got the most
capital for giving away the least possible. (This shwredness probably bodes
well for their ability to make money in the future.)

Usually tech stocks go the other way because the company doing the IPO has
very little leverage to set their own price; investment banks are the
gatekeepers and won't let anyone through unless their customers unless they
and their most-favored-customers make a bundle on the initial sale. Facebook
was able to flip that dynamic around and make sure that _they themselves_ made
a bundle while all the investment banks' customers lost out. It takes both
leverage with the investment banks and knowledge of the demand curve in order
to pull something like that off.

If the overoptimistic end up being right on the long enough timescale, they'll
get their money back. But for the moment there are too many pessimists about
the future potential of Facebook for a $38 buyer to be able to get what they
deem a fair value.

Buy low, sell high, simply means being optimistic when others are overly
pessimistic, and being pessimistic when others are overly optimistic. There's
a bit of predicting what the objective financials of a company are, but it's
far more about realizing the psychology of everybody else with money to trade.
It's not just Silicon Valley engineers that are overoptimistic...

------
RockyMcNuts
Blodget made some good points:

[http://www.businessinsider.com/facebook-lockup-
release-2012-...](http://www.businessinsider.com/facebook-lockup-
release-2012-8)

You want a high IPO price, but not so high that you can't meet expectations
and disappoint. Get tagged as an underperformer and it makes it hard to do
future stock acquisitions, financings, hires.

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joshuahong100
Wow.. to the top level commenters who rationalize the merits of the Facebook
IPO as successful in extracting the maximum amount of money for investors and
employees.. this is the type of logic that warrants the criticisms thrown at
Silicon Valley.

Not withstanding the fact that the redistribution of wealth was based on
'hype' and just a douchy move, does no one seem to understand that the IPO
market will inexorably implode yet again through such self-serving actions,
thereby closing future IPO opportunities for companies with real revenues and
growth?

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pbreit
This is a stupid argument. The character "flaws" the author cites are
basically why much of the technological progress of the past several decades
originated in Silicon Valley.

~~~
wkasel
Let's not use the word stupid. I live and work in this ecosystem. If you saw
what I saw you would agree.

~~~
pbreit
You're lecturing me about language? I've seen as much or more and I think
"stupid" is the correct word. The supposed "flaws" you mention are the exact
attributes that have made Silicon Valley the originator of much of
technological progress in the past few decades. Selecting a once-in-a-decade
company to extrapolate from is, well, stupid.

------
PaulHoule
SV was the leader in social media three years ago but today the interesting
companies, like Pinterest, are run out of places like Iowa.

~~~
rdl
I think the people who work at Pinterest's HQ in downtown Palo Alto would say
they're not in Iowa anymore.

------
azat_co
Nice article, William! :)

~~~
ChuckMcM
Seems a bit snarky to me. Engineers don't price IPOs, bankers do. And because
of that it reads more like

"I'm really pissed off you are now rich and I am still not rich."

or perhaps

"I thought it was going to go through the roof and so I bought some and it
didn't so I lost a lot of value and now all this stuff that I'm reading makes
me look stupid for having believed it in the first place."

I've mentioned elsewhere that when I read stuff like this I feel sympathy for
the Author because I think they might be in a lot of pain over something and
trying to work through it. Not everyone has good tools for that, sometimes
just screaming at the top of your lungs makes you feel better.

As a person who lives in Silicon Valley and could easily be painted by
William's broad brush strokes as someone who "has their head so far up their
ass that they are eating their own bullshit" I regret to say that I've not
lost (or gained) any money on Facebook stock, don't own a single share, and
like a lot of people here don't own it because I didn't feel it merited a
price over $30 a share. This isn't because I'm a genius and or smarter, its
because I looked at the business and said, "You know I don't think it supports
that valuation."

But that said, its a hell of a business. Facebook made over a BILLION dollars
last quarter, that is over four billion a year at those rates. I was at Sun 10
years and it just just crested $3B on its ways "hopefully" to $5B and folks
were estatic. It is pretty impressive what these Facebook folks are doing.

But what William is so upset about is its _stock price._ And to that I'd say
why the hell do you care what the price of Facebook's stock is? What does it
matter? Smarter people than you are evaluating it every day and making bets on
whether its priced higher or lower than its future value, as they play that
game they exchange money, it's sort of a score keeping system with them, and
they have more strategies than a roulette player has ways to "beat the house."

Now if you're an executive at Facebook you care because it limits your options
when it goes down, as an employee maybe it changes the model plane or boat you
can buy, as an outside observer it means _nothing._ So why the angst?

~~~
wkasel
Interesting assessment. I live in Silicon Valley, I don't own a share of FB, I
do trade frequently. Like you, I made an assessment. My frusteration comes
mostly from reading on tech blogs what Facebook "needs to do". Techcrunch acts
like they are Bloomberg or something, which goes exactly with my broad brush
stroked point as you said.

It's actually the valuation I care about vs. the stock price, but people tend
to understand that better, so I use that as a unit instead of valuation.

The bottom line is yes, I write pointed, and passionately, I'm not personally
at a loss for FB, I'm just tired of hearing "expert opinions" even on
Bloomberg.

~~~
ChuckMcM
Ok, I think it would be more effective for me then if you started with what
you cared about and why you cared about it.

So your frustration is with blogs, written by people who are paid in
proportion to how angry or scared they make their readers, using Facebook as a
stalking horse to drive page views? I can certainly understand if that is the
case, why not say that?

Instead you said this : "The root of this problem is core to the DNA of
Silicon Valley types. "

You didn't say the people who blog about Silicon valley (heck they may not
even live here) you just said "Silicon Valley Types" which covers a lot of
people, many of whom like the folks who founded Y-Combinator probably don't
think of themselves a collective that _"These character flaws are why we (the
collective known as Silicon Valley) thought that a company with piss-poor
revenues could IPO at an overpriced valuation, and have the same fan fare for
over-valuation as it did in the valley. "_

You impeach yourself by calling Facebook's revenue 'piss poor', it isn't, and
then accuse "us", those who live in Silicon valley, with 'over valuing' when
in fact that was the work of a collection of banks, based primarily in New
York city.

I would love to hear passionate, pointed, editorial about how bankers and
journalists unknowingly (or perhaps knowingly if you are the conspiracy type)
in the creation of a value perception, but its a hard case to make here. There
were literally years of trades in FB you could look at from SecondMarket, and
there are a number of pretty cogently written analyses of their business model
and the _potential_ of their business. The Techcrunch whine about how it's not
the bubble they were hoping for, and were so sure it was, will pass. And a lot
of young people who weren't here for the dot com fiasco (or at least they
weren't watching it closely) could learn from clear insights about what really
makes a company worth a billion dollars to investors, or worth a hundred
billion.

You could do that instead, start from what you care about and bring us along
as readers, telling us why you care and perhaps educating us as to why we
might want to care as well. That may or may not be effective, but it certainly
would be less snarky I expect.

