Facebook: The List of Incompetents

By Felix Salmon
May 23, 2012

It’s going to be a long time before the various lawsuits shake themselves out, but one thing’s already clear with respect to the Facebook IPO: absolutely no one has come out of it looking good. It’s worth going down the List of Incompetence here, because regardless of whether any of this was illegal, there are a lot of extremely well-compensated people who, to use a technical term, screwed the pooch on this one.

Top of that list, frankly, is Facebook CFO David Ebersman. The WSJ’s account of his central role in the offering is reasonably definitive: a lot of decisions normally outsourced to banks in the markets were made, in this case, by a tech-company executive in Menlo Park.

Ebersman didn’t make one big mistake, he made three. Firstly, as CFO, it was his job to accurately forecast Facebook’s second-quarter figures, and give the company’s banks a good feel for where they would come in. He failed so badly that he was forced to re-file the IPO prospectus just days before the deal came to market, and to whisper in his bankers’ ears that they should probably cut their forecasts for the company’s revenues.

There’s no excuse for getting that wrong, but if there was an excuse, it would be that Ebersman was too focused on the year-long process of managing an awesome IPO. Ha! He screwed that up, too, of course — not least by upsizing the deal at the last minute, raising the number of shares being sold by 25%. In hindsight, that was a very bad idea. But then, after that, he made his third major mistake: he priced the deal for perfection, at $38 per share, even as big institutional investors — the only ones who knew about the new revenue forecasts — were saying that they had no real desire to own the stock at more than $32 per share. When you’re selling $16 billion of stock, the marginal price-setters are always going to be institutions, rather than price-insensitive retail investors willing to buy Facebook on name recognition alone. And those institutions were never really willing to provide a strong bid above $38.

While most of the blame at Facebook’s end should properly be shouldered by Ebersman, that doesn’t mean Mark Zuckerberg can be let off the hook entirely. It’s his company: the buck stops with him. And he did the IPO no favors at all. First, he insisted on an unprecedented level of individual control over a $100 billion public company; institutional investors never like that. And secondly, he clearly viewed Wall Street and its investors with thinly-disguised contempt, slouching into IPO meetings — when he bothered to turn up at all — in his hoodie, and signally failing to provide the outward-facing leadership that investors crave. Zuckerberg’s refusal to play the Wall Street game is admirable, in some respects — but at the same time is completely inconsistent with a desire to sell $16 billion of shares at a $104 billion valuation.

The third member of Facebook’s leadership team who deserves some blame here is Sheryl Sandberg, the COO, and the person whose job it is to help Zuckerberg navigate the external world. Sandberg also conveniently recused herself from many IPO decisions, which doesn’t seem like a very good idea in retrospect. Either she had too much faith in Ebersman and Zuckerberg to do the right things, and should have been much more involved — or else she was deeply involved, behind the scenes, and therefore responsible for some significant part of the resulting fiasco.

Facebook’s board members and investors look very bad here, too, coming off much more short-term greedy than long-term greedy. Many of them cashed out in the IPO, in a clear sign that they had little faith in the share price going forwards. The board’s job has historically been to rubber-stamp Zuckerberg’s decisions, and to provide him with advice as and when he asks for it. Now, however, the board has a fiduciary responsibility towards all of Facebook’s investors, including the ones who bought in at $45 per share. But there’s no sign that anybody on the board saw the new investors in Facebook as anything more than muppets.

On the Wall Street side of things, the shame list is topped, indubitably, by Morgan Stanley’s technology banker Michael Grimes. He worked hand-in-glove with Ebersman, and all of Ebersman’s decisions can be considered Grimes’s decisions as well. More generally, it was Morgan Stanley’s job to understand exactly what the real demand was for Facebook shares — to sound out investors and price the company just a little bit below what the market was willing to pay. And there’s no doubt that Morgan Stanley failed miserably in that job.

And then there’s the whole scandal of the buried revenue forecasts: the way that Morgan Stanley whispered the new numbers in select clients’ ears, without ever letting the broader investing public know about the downgrade. If you want to develop a reputation as an untrustworthy bank which plays favorites and leaves the little guy out to dry, you could hardly do so in a more effective manner.

The other banks in the deal — JP Morgan, Goldman Sachs, and the rest — don’t deserve quite as much blame as Morgan Stanley, but their actions were more or less identical — they all downgraded their forecasts in secret, and they all went along with the size and pricing of the deal, in return for multi-million-dollar fees. If you bought your Facebook IPO stock from Goldman, you’re going — rightly — to blame Goldman first and foremost if they didn’t tell you about their downgraded forecast. And more generally this deal goes to prove that Wall Street acts very much like a cartel: all the banks behaved in an identical manner, and not one was willing to make a fuss or walk away from a bad deal. They all got stars and dollar signs in their eyes, and behaved like fools as a result.

Then, of course, there’s the Nasdaq. Read Nick Carlson’s interview with an anonymous hedge-fund manager for some of the gorier details here, but in general anything that Nasdaq could mess up, it did mess up. In short: the stock never opened at 11am, as planned, because Nasdaq’s computers weren’t up to snuff. There was a five-minute delay, and then there was a second, 25-minute delay, during which time Nasdaq switched over to a second computer system.

The whole thing turned into a complete disaster. The second computer system didn’t work as planned, and there was an enormous amount of confusion — which still hasn’t been cleared up, in some cases — about where and whether various investors actually managed to sell their stock. As a rule, if you placed an order between 11:05 and 11:30 on Friday, you’re probably in a world of pain today, and you might be relying on the Nasdaq to make you whole for your losses: while you thought you were selling at $42, you might not actually have been able to sell until the shares were at $38 or even less. It seems that the opening price of $42.05 was based only on orders received before 11:05, and ignored all orders after that time, most of which were at much lower levels. Which helps to explain the initial and chaotic plunge in the stock price.

Naturally, when a stock is behaving like that, it takes a very brave investor indeed to dive in and go long at a frothy valuation. And so it’s entirely reasonable to blame the Nasdaq for the failure of the Facebook IPO. It’s their job to get this kind of thing right; instead, they got it spectacularly wrong. End of story.

Finally, there are all the investors, including that anonymous hedge-fund manager, who bought into the IPO even though they knew that the valuation was incredibly high, and are now casting around for someone else to blame for their losses. It’s impossible to feel any sympathy for these people — especially institutions who had no appetite for stock at more than $32 per share, but put in large orders at $38 anyway just because they were counting on Morgan Stanley to give them a nice opening-day pop. If you pay 100X earnings for a hyped internet stock on its first day of trading and then you lose money, you frankly had it coming.

All of which means that the winners in this whole game were you and I: the quiet skeptical masses who simply sat back and watched the farce unfold. In the game of Facebook IPO, it turns out, the only winning move was not to play.


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nice WarGames quote!

Posted by dminkin | Report as abusive

It’s hard to disagree with any of this, but I think much of the anger being directed at MS is based on the expectation that MS would require FaceBook to leave more money on the table for its “preferred” investors — hedge fund managers, mutual funds, whoever — as this is what happened routinely in the days leading up to the dotcom bust. Basically, if the question here is, who should profit from an IPO, then clearly, it is the offering company that is entitled to be paid for its initial worth and investors should not be able to cry for having been forced to pay a fair value. (A company whose stock doubles the day after an IPO has left an awful lot on the table that it could be using to fund operations and growth going forward.) However, if the question is, should the offering company be able to hide its true value from all but a few favored investors, then the answer is clearly no.

Would that the laws and regulations in this area be so simply stated.

Posted by rb6 | Report as abusive

“Anonymous Hedge Fund Manager: …this should have been a blockbuster. This should have traded to $60 or $70. This should have launched a wave of tech IPOs.”

Wishful thinking?

Posted by EricVincent | Report as abusive

Nice summary Felix of what Ritholtz already said…

http://www.ritholtz.com/blog/2012/05/ple nty-of-blame-to-share-for-faulty-faceboo k-ipo/

Posted by Sad_Oligarch | Report as abusive

Good stuff, Felix.

Posted by krimsonpage | Report as abusive

Not sure I agree there’s a lot of blame for people not getting the information on the analyst downgrades.

I could be wrong, but I have a suspicion that even if Facebook (instead of “whispering it in bankers’ ears”) had placed it front and center on page 1 of its S-1/A filed on 5/16 it would have made… no difference. I just do not believe that most of the buyers at the (rich) price of $38 ever even opened the prospectus.

(I note that I say this with no malice — the fund I’m at put in for an allocation and flipped our meager 15k share allocation at $42 on the open and I can promise you no one here read the prospectus.)

Posted by CasualSophist | Report as abusive

That’s a good article. One nit pick:

“…the winners in this whole game were you and I…”

No. The winners were you and me. Not I.

The “hyperactive I” is a scourge of modern day English. Even for the English.

Posted by sagreer70 | Report as abusive

I sat and watched. harbored thoughts of shorts but did not have the guts to bet against so much public goodwill for Facebook (something I do not use)

Posted by DNP | Report as abusive

How much is a share of Facebook worth? Well the earnings for last year seem, as best I can tell, to have been 31cents a share. Now Google has a PE ratio of under 20. If we put a PE ratio of 20 onto Facebook that would suggest a share price of $6.20. If it earned 31 cents in the last quarter, then the yearly earnings would be $1.24. At a PE ratio of 20 that would be $24.80.

Posted by Chris08 | Report as abusive

Why is anybody surprised at this set of outcomes for a company that for all that it’s said, simply didn’t want to go pubic. Hell, even today, Zuckerberg controls 50% of the vote so is it in any real sense a public company anyway?

Posted by GregHao | Report as abusive

Very good article Felix. Just one thing – the worst thing you said about Zuckerberg was he wore a hoodie to IPO meetings? So what? That’s hardly a crime. Greed isn’t a crime either but I would have thought that would have been a better bat to hit him over the head with. All this hoodie thing proves is that America is more interested in image than substance…

Posted by FifthDecade | Report as abusive

To CasualSophist, I could not agree more.

This was always going to be a flip.

Chance of a decent allocation? Minimal.
Normal rules of valuation apply? Nope.
Worth building a model and keeping up with analyst forecast numbers? Nope.
Return on your time for actually reading the prospectus? Negative.

The right way to play this was to keep a close tab on how over-subscribed it was and then wait for a pop to off-load, as you did.

Also, giving the CFO a hard time for mis-forecasting Q2 isn’t fair.
Wasn’t the previous prospectus out mid-Feb??
Many companies guide for a Q mid-way through the Q and STILL get it wrong.
On a rapidly growing beast of a company like FB, not knowing how June is going to turn out four months in advance is understandable.

Posted by TinyTim1 | Report as abusive

Devil’s advocate would say that Ebersman and Grimes did their jobs, which for Ebersman was to maximize the dollars raised in the IPO, and for Grimes was to maximize the lead book-runner’s fee for Morgan Stanley. They were able to sell the most shares they possibly could at the highest possible price. What happens on the secondary market is not as much a concern for them. True, they lined the pockets of the insiders and screwed anyone who bought at the IPO price, but isn’t that what the people who pay them expect them to do? I’m not saying it’s pretty, fair, or ethical, but that’s the way the game is played. I would argue that NASDAQ is most at fault. Botching the opening probably spooked the market, generated rumors, and created enough of a hesitation for investors waiting to buy that the demand slacked off within the first hour of trading. Had the opening been executed flawlessly, there may have been enough momentum for the price to pop on the first day like people were hoping.

Posted by GMAFB | Report as abusive

@Felix Salmon, this is your best piece ever!!!
I couldn’t have said it better myself. The only people who came out winners were people like us who know that Facebook is way overvalued………

Posted by KyleDexter | Report as abusive

Oh dear, Henry “Zuck-Da-Man!” Blodget is going to fall out with Salmon again.

Hey Henry, we adored how you were talking the “$74 bids in Europe!!” (your exclamatives, not mine) last Friday. By the way, the adjective i’d prefer to use for you isn’t allowed on the Reuters comments section.

Posted by ottorock | Report as abusive

Actually Felix is correct according to traditional grammar: “it is I” not “it is me”.

http://grammar.quickanddirtytips.com/gra mmar-linking-verbs.aspx

Posted by danyzn | Report as abusive

Felix, might I suggest that you unpack your thinking a bit more as to what you think was some kind of error.

The screwups regarding execution are clearly bungling for which there is no justification.

The screwup regarding projected 2nd quarter earnings I have no strong feelings about. I assume there are general expectations of behavior here, but I can’t say I’m wild about a system that decides to supplement the official release of material company info with unofficial releases of that info to favored parties; so I can’t say I’m especially outraged when this system broke down.

However you seem to be especially upset about the fact that the IPO opened at 38, didn’t rise much, and fell to 32. I can’t see what this outrage is based on. I’m not a social darwinist, thrilled by every example of the strong preying on the week; but I also don’t think we can completely protect people from their stupidity. You (to take a prominent example) were very vocal in saying that this was not an IPO for which participation made sense for most people. Zuckerberg had made his lack of interest in the whole affair, and the fact that he will run FB as he wishes, quite clear for a long time.
Even after all this, you now seem outraged that things played out pretty much precisely as you predicted. Why exactly should I be outraged?

There seems to be a very strange mental model here of the purpose of an IPO. The purpose of the IPO, surely, is to raise MAXIMUM REVENUE FOR THE COMPANY. it’s not to make Wall Street rich; it’s not to reward cronies. This IPO succeeded spectacularly in that goal. There’s justified outrage, yes, if there are lies and misrepresentations about how much money FB will make, but we all know FB is a gamble. And if you want to gamble on FB, your attitude should be buy and hold for a few years, not buy and be upset that you can’t flip tomorrow.,

Looks like a whole lot of Stockholm syndrome to me.

Posted by handleym99 | Report as abusive

Oh, come on Felix. What is the purpose of a stock offering? It is NOT to provide quick, speculative profits to buyers.

The purpose of an IPO is to raise money for a company – period. If you are the fiduciary of the company, you sell stock at the maximum price you can manage so your company recieves the maximum amount of cash for the smallest number of shares.

Facebook did that perfectly. Facebook generated a huge amount of money that it can now use. So the stock price has drifted down? As far as Facebook is concerned, all shares already sold are money in the bank. Facebook can always sell more.

You honestly forgot that the secondary market for shares is exactly that – secondary? Buy and hold Facebook for 7 years and you will make lots of money. Stock prices always fluctuate.

Would I buy Facebook at $38 a share now? Naah. I’ll buy, but later on. But looking at it with my entrepreneur hat on, Facebook played its hand very well.

Now let’s see what Zuckerberg does with all that money he raised. I think he’ll do fine.

Your plaffle on the hoodie thing? Oh-for-god’s-sake-you-can’t-be-serious. What more proof is there that Zuckerberg is playing his position flawlessly could there be than getting top dollar for Facebook? That’s his job! His job is NOT to lowball the price in order to put money that could go into building his company in everyone else’s greedy pockets. What-on-earth-are-you-thinking?

A company has zero fiduciary duty to a buyer of shares until after those shares are bought.

Posted by BrPH | Report as abusive

“It’s me” is plenty traditional, according to MWDEU:

“… thinking verily it had been her.” —Samuel Pepys, diary, 1 Oct. 1666
“It is not me you are in love with.” —Sir Richard Steele, The Spectator, No. 290, 1 Feb. 1712
“Ah, it is her you love.” —Charles Reade, Hard Cash, 1863
“For it was not her one hated but the idea of her.” —Virginia Woolf, Mrs. Dalloway, 1925

That said, Felix’s sentence is totally fine as well. Respectable people use both “me” and “I” after the verb “to be.”

Posted by raghavrk | Report as abusive

Facebook’s IPO was extremely successful, especially for the company. The CFO did an amazing job getting the highest dollar price and selling the most shares possible. That is his job and he hire Morgan Stanley and other banks to conduct a sales and marketing pitch. They did their job very well too. The fact that investors who purchased the shares screwed up has nothing to do w/the success of Morgan Stanley and the success of Facebook… this IPO was a HUGE SUCCESS.

http://stegermeister.blogspot.com/2012/0 5/facebooks-ipo-was-extremely-succesful. html

Posted by Meistro | Report as abusive

Well summarize Felix.

Posted by MichaelOlivero | Report as abusive

“…completely inconsistent with a desire to sell $16 billion of shares at a $104 billion valuation…”

Perhaps you missed the part where he did exactly that? Now, in the long term, was it a good move for Zuckerberg to fleece the investing public like that? An interesting question. But nothing I’ve ever read or heard about the man suggests it’s out of character. Have fun, shareholders!

Posted by ckbryant | Report as abusive

Thanks for the link, danyzn. Grammar Girl to the rescue yet again!

Posted by BajaArizona | Report as abusive

(quote) “was it a good move for Zuckerberg to fleece the investing public”?

like a pseudo-friend feeding on the insecure and the narcissistic

if you need facebook to announce yourself to friends and the rest, then this IPO will keep your life online

however soon expect to receive a bill for the service – zuckerburger will offer your online “need to keep your life” to placate the angry (stupid) investors (all 901,000,000 of you)

Posted by scythe | Report as abusive

“All of which means that the winners in this whole game were you and I: the quiet skeptical masses who simply sat back and watched the farce unfold.”

Really? Were there no pension funds and the like suckered into this either?

Posted by Montanareddog | Report as abusive

I don’t always trust them as a source (for example, I think these plots are generated from UQDF rather than TotalView), but Nanex has an interesting presentation on the topic showing stuff breaking:


FWIIW, the facebook link thingee I tried to use to log in here wanted to give Reuters access to all my data. Irony.

Posted by slocklin | Report as abusive

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