Chart of the day, Facebook IPO edition

By Felix Salmon
February 14, 2012
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There are two ways of looking at the $5 billion or so that Facebook is going to raise in its IPO. One is to ask what on earth the company is going to do with all that money: it’s already making substantially more in the way of profits than it is likely to want to spend, and the chances are that the $5 billion is just going to go straight into the bank, where it will earn roughly 0.77% per year. This is not the best use of shareholder funds, and it’s hard to see why Facebook’s CFO would want the cash pile to be any bigger.

On the other hand, $5 billion is very small as a percentage of Facebook’s market capitalization. Here’s Allan Sloan:

If Facebook’s offering ends up being the advertised $5 billion, and the company’s stock market valuation is in the expected $75 billion to $100 billion range, it means that only 5 to 7 percent of the company’s shares will be available to public investors.

While there are all sorts of rationalizations for having such a small public offering relative to a company’s size, the real reason, as any Street insider will tell you, is to create an initial shortage of stock so that the share price runs up when public trading starts.

It’s not enough for Mark Zuckerberg & Co. to have created an amazing, incredibly valuable company over an incredibly short period. They feel the need to use this tacky market trick to drive up Facebook’s value even more.

Sloan has a point, here: it’s very rare for companies to go public while selling less than 10% of their stock. Here’s a chart from Thomson Reuters, showing the free float at IPO for all US issues from 1/1/2000 onwards which had a market capitalization at IPO of more than $1 billion.

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As you can see, it’s very rare to go public with a float of less than 10% of the company: the average for tech companies is 19%, and the overall average is 26%.

And if you look at IPOs which raise more than $500 million, the percentages get bigger still: if you’re raising more than half a billion dollars, then tech companies end up with a free float of 34% of their company, on average, while overall, companies float 43% of their shares.

So, is Sloan right? Is Facebook’s small free float a “tacky market trick”?

My feeling is that it isn’t — and that it’s rather a function of the way in which Facebook stock is distributed. Since the company doesn’t really need to raise equity capital, the only other way to increase the free float is to persuade existing shareholders to sell their stock into the IPO. Mark Zuckerberg certainly doesn’t want to do that — to the contrary, he wants to retain as much stock and control as possible. And most of his fellow shareholders are similarly rich and fond of their stock, preferring to wait a while before selling.

In other words, what we’re seeing here is the natural consequence of what happens when the stock market essentially forces companies to be profitable before they go public. In the olden days, when companies went public because they needed the money, they would sell quite a lot of stock. Today, that’s no longer the case, especially in Silicon Valley, where capital-raising rounds are generally done privately, with VCs. If Facebook hadn’t been able to raise well over a billion dollars privately, then it might have gone public earlier, selling more of its stock in the process. But given the way that equity investing in early-stage companies has moved from the public to the private markets, what we’re seeing is pretty normal, and not really a tacky market trick at all.

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