Goldman’s Facebook plan falls apart

By Felix Salmon
January 17, 2011

When the news came out that Goldman Sachs was orchestrating a private offering of Facebook shares at a $50 billion valuation, those shares overnight became an even hotter commodity than they had been up to that point. Check out the results of the periodic SecondMarket auctions: the three auctions in December, before the Goldman news was public, cleared at between $21.01 and $22.75 per share. The first auction after the Goldman news, by contrast, cleared at an all-time record of $28.26 per share — that’s a valuation of over $70 billion.

Clearly the Goldman news moved markets — a lot. And equally clearly, that’s very problematic in terms of securities law. Andrew Ross Sorkin explains why Goldman now feels forced to restrict its offering to non-US investors:

Federal and state regulations prohibit what is known as “general solicitation and advertising” in private offerings. Firms like Goldman seeking to raise money cannot take action that resembles public promoting of the offering, like buying advertisements or communicating with media outlets.

This is a point which was made before Goldman’s latest announcement, for example by Chris Whalen:

Look, for example, how the Facebook portal got a lot of ink last week because of the superlative public relations job by GS. In feeding their “private investment” hype to the Big Media, GS was effectively front-running their own private market, the little ghetto called Face Book that they created apparently to evade securities laws.

All of this serves to underline the difficulties inherent in trying to put together a private market in Facebook stock. In Goldman’s ideal world, and quite possibly in Facebook’s ideal world too, Goldman could broker private transactions in Facebook shares for years to come, obviating the need for Facebook ever to go public.

Received opinion has it that Facebook might as well go public once it exceeds 500 shareholders and starts making public large amounts of information about itself in 2012. And today’s news only serves to underline how difficult it is for a highly-visible company, and its advisers, to maintain a market in its securities while remaining private.

Selling the shares privately isn’t going to be a problem, reports the WSJ:

A total of about $7 billion in orders for Facebook shares has poured in, according to a person familiar with the matter. That means it is highly likely that Goldman still can pull off the offering at its original size without U.S. investors. Chinese demand is especially strong, said one person familiar with the offering.

“They’re still committed to doing the deal at the original size,” one Goldman client said.

But Facebook is a US company, and while it can surely raise lots of money from Russian and Chinese investors, that’s always going to look like a stopgap solution. This news definitely increases the chances of a Facebook IPO in 2012, while at the same time decreasing the probability that Goldman will lead it:

The struggles of the offering may also deal a blow to Goldman’s relationship to Facebook and the firm’s prospects of leading the social network’s long-awaited initial public offering, expected in 2012…

However, in the past two weeks, the relationship between Facebook and Goldman has grown increasingly tense, people involved in the offering said. Accusations about the news leak have flown back and forth, these people said.

The fact is that although remaining private is very attractive in theory, in practice it’s likely to come with a lot of unwanted attention from the SEC, and its own set of downsides. Still, an IPO is far from a foregone conclusion.

If Goldman Sachs feels left out of the running when it comes to the Facebook IPO, it’s going to be even less likely to be a model shareholder when it comes to its own $450 million stake in the company. Here’s TED, making an important point:

Do you realize how difficult it is for investment banks to put their own capital at risk to earn an underwriting or placement mandate? We hate, hate, hate it, Mr. Mallaby. It goes contrary to everything we aspire to do. Goldman only did it because it thought it could make great fees on Facebook’s eventual IPO.

And here’s Peter Gallagher, who notes that Goldman’s boilerplate talks about how the bank “may at any time further reduce its exposure to its investment in Facebook through hedging arrangements”.

Goldman could write options against its own Facebook shares and likely has discretion to do so against the fund’s holdings.

In other words, Facebook has a speculative shareholder for the first time, now that it’s made its decision to get into bed with Goldman. And Goldman will think nothing of buying puts or selling calls on Facebook shares — or even dumping its shares outright, if it’s allowed to do so — if that’s what it needs to do to protect its $450 million investment.

As the same time, however, one of the main unwritten rules of IPOs of young companies is that they always need to be priced at a level above their last funding round. If Facebook can’t IPO at a valuation significantly north of $50 billion, then it probably won’t come to market at all. (That probably explains why bidders on SecondMarket are happy to buy at a $70 billion valuation: they’re betting that when Facebook goes public, it’ll be worth more than that.)

A lot of stuff can happen to Facebook between now and a 2012 IPO. And if Goldman is shorting Facebook rather than massaging its valuation and orchestrating an IPO which values the company at $70 billion or more, then maybe Facebook won’t go public at all next year. Maybe, indeed, Facebook will learn from this whole episode that dealing with investment banks is an unpleasant and expensive exercise, and will try to avoid doing so in future as much as it possibly can.

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