Forget about hype, valuation, and selective disclosure for the Facebook (FB) IPO flop - it can be largely explained by Economics 101. Here are the details:
- The initial offering was 337 million shares, as outlined in this S-1
- The original range was $28 - $35, as outlined in the same S-1
- Late in the process, the offering was raised by 25% to 421 million shares, as outlined in this amended S-1
- Late in the process, the price range was increased to $34 - $38, a 14% increase at the mid point. (From amended S-1 above)
- The last internal valuation conducted on January 27, 2012 by the Facebook board pegged the per share value at $30.73 (see page 75 of this S-1).
Now let's asses the supply / demand dynamics of the IPO and the impact of the changes.
- At the initial IPO offering of 337 million shares, it would have been 11.2x larger than the Groupon (GRPN) IPO.
- The original range implied a market cap between $77 billion and $96 billion (this assumes 2.7 billion total shares outstanding as detailed in Yahoo! Finance).
- By increasing the size of the offering, the underwriters brought 84 million incremental shares to market. This was 2.4x the size of the entire Groupon IPO. It's also 82% of the 103 million total shares outstanding at LinkedIn (LNKD).
- The increase in the price range vaulted the implied market cap to $93 billion to $104 billion. The mid point of $98.6 billion was $12.0 billion higher than the previous mid point - the entire market cap of LinkedIn.
- Based on the $38 IPO price, Facebook and the underwriters implied that Facebook was 24% more valuable than in January, despite Q1 revenue declining sequentially and admitting that mobile adoption was hurting revenue growth.
Think about the magnitude of supply the underwriters demanded the market to absorb. Combined with a super-rich valuation of 88x 2011 EPS ($0.43 on a pro forma basis), you can see that odds were starting to become stacked against a successful deal. We made a similar warning about the Groupon IPO analysis.
Here are some charts that put all this into perspective.
These graphs provide visual proof that there is a tremendous amount of supply (Facebook stock) that needs to be absorbed by the market. Realizing the staggering amount of total shares outstanding, we are surprised that management and VCs have been so eager to hand out stock over the course of the company's short life -- especially compared to other technology-related companies. The only stocks we came across with a higher absolute share count were Bank of America (BAC) and Citigroup (C), but that's because existing shareholders experienced massive dilution when the government had to bail them out from the financial crisis.
In terms if Economics 101, the double whammy of 25% more supply combined with a 14% price hike seems at odds with the supply / demand curve reality. Most people expect prices to decline in the face of more supply, so we are not sure what the bankers were thinking. Perhaps they truly believed that all the orders they received were genuine, not people looking to flip the deal. However, this a game that is always played by Wall Street, hedge funds, and mutual funds jockeying for allocation, so the bankers should have been able to gauge this real demand more accurately.
So now the question becomes how much the lock-up expiration will pressure the stock price because there will be huge quantities of stock coming to market starting in August. This is a hard question to answer, so we won't even make an attempt.
However, an important takeaway from this analysis is that investors need to pay close attention to deal dynamics in IPOs like Facebook. Growth and valuation are hugely important to understand, but so too are the absolute size of the deal and the % of total shares being offered. Be sure to analyze these key metrics before putting in your buy order for the next hot IPO. (Our guess is that it's Twitter or Evernote).
Additional disclosure: Facebook is covered in our Research Center, where we curate content to conduct in-depth stock research on best-of-breed companies.