Facebook IPO - Morgan Stanley Risked Break Issue

May 17, 2012. $16bn raised in an historic IPO, second only to Visa's 2008 IPO of $17.86bn.

This is huge, knowing that we're talking about an 8 year old company deciding to go public after having done a great deal to avoid such an eventuality.

Priced at $38/share with a $104.2bn valuation, all we can say at the moment is that Facebook hasn't lived up to investors and profit-seekers' short term expectations. There was never a significant pop to this IPO. Since then Facebook has lost just over 24% of its market cap.

 
Source: Yahoo Finance

 
Source: Google Finance

Facebook's shares started trading privately in the SecondMarket in 2008 and has since then grown from $3.5 in April 2008 to $42.72 in April 2012, valuing it at ~ $106.8bn (Chart beneath), where ~75% of these buyers were professional money managers (See Chart).

  

 

Source: SecondMarket

The underwriters were obviously under pressure to price the IPO offering close to trading levels that were already in place. So it didn't come to me as a surprise when Morgan Stanley upped the offer price from the $28-$33 range to $38, although I do still think the valuation should have been between $28 and $33. 

Did Morgan Stanley play into a break-issue risk? The answer is YES, although it got Facebook a few more billions in dollars (which is excellent for future sales pitches for the involved underwriters) and the underwriters made more money - $0.418 per IPO stock offered, translating to 1.1%, or nearly $176mn. The lead left - Morgan Stanley, JP Morgan, Goldman Sachs and 30 other banks have pocketed a good deal.

Facebook had always tried its best to avoid going public. The reason why it had to do so now was because in December 2011, its shareholder count exceeded 500 - and according to a 1964 SEC rule, any Company with 500 or more 'shareholders of record' is required to file its detailed quarterly and annual reports with the SEC.

Facebook had tried its best to rein in the number of its shareholders - and had started issuing Restricted Stock Units (RSUs) instead of shares / share options after it had already issued c. 200 shares to its employees. RSUs aren't considered shares until the company goes public. Needless to say, this was cause for dissent among its employees back then. Even very recently, in January 2011, when Goldman Sachs infused $450mn to value Facebook at $50bn, the deal was structured such that the transaction would count as one shareholder's position. Having said that, Facebook doesn't have much to complain about, now that it's public. And here are the key reasons:

It's all about the Money: Add $16bn to Facebook's $3.9bn cash pile. It can fulfill its strategy of acquiring more users by buying out companies with niche services / applications, catering to an untapped user base

Tax Gains: Facebook stands to gain heavily on future tax payments, saved primarily on the vesting of RSUs and the exercise of options, which could be around $7bn. Facebook paid heavy taxes of ~40% on its pre-tax operating income in 2010 and 2011, way higher than the marginal tax rate of 35%. So looking at it another way, Facebook would get $1bn tax rebate on every $3bn of operating income for the next $20bn of pre-tax operating profits

Zuckerberg in Charge: Zuckerberg has 28.2% stake ownership after the IPO, but still retains 55.9% voting rights thanks to the issue of Class B shares with 10x voting power compared to the Class A shares offered through the IPO - meaning that Facebook is a Controlled Company with no Independent Directors

All in all, a great deal for Zuckerberg and Facebook. Whether it's sweet for investors, my take is: Nope. Not for the near term. And if you're looking at a one-year horizon, a $47 share price is likely - strictly on a fundamental valuation basis.

I'll discuss in detail on my valuation model and IPO pops in following posts.

Cheers,

AJ