Facebook’s SecondMarket muppets

By Felix Salmon
May 30, 2012
fine art prices: a place for the rich to spend lots of money and feel great about owning something very few other people can have.

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Remember how excited SecondMarket was about the Facebook IPO? I’ll bet they’re not nearly as excited any more. Because if anything demonstrates that there’s a venture-capital bubble in Silicon Valley right now, it’s Facebook.

The chart above shows the valuation of Facebook on SecondMarket, every month from January 2011 through April 2012; the red bar shows the valuation of Facebook at the close of trade today.

Now it’s true that if you bought Facebook shares on SecondMarket before 2011, then you’re in the money right now. But the chances are, you didn’t:

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This chart, from SecondMarket, shows that fully 78% of all transactions in Facebook took place in 2011 or 2012. What’s more, pretty much everybody who bought Facebook shares on SecondMarket is still locked up. They never got the opportunity to exit at the IPO price of $38; indeed, they’re going to have to wait long painful months before they can sell at all. (They can of course now short the stock, or buy puts, to try to protect their downside from here on out; that in turn is only going to further depress the price of the stock.)

Mary Meeker explained the consequences, today:

Valuations in the private market are going to make it “difficult to go public.” The valuations make it “difficult to justify the goals.” The prices are going up and up. And the businesses are not keeping up.

So, when these companies start to look for public market exits, there’s a good chance the “private market will lose money.”

When Meeker’s talking about the private market, she means investors like her own firm, Kleiner Perkins, rather than the kind of people who buy shares on SecondMarket. But the principle is the same. An IPO can be looked at as another fundraising round, and no one likes a down round. In the case of Facebook, it seems as though Facebook’s share price is still just higher than its last official capital-raising round, when it raised $1.5 billion at a $50 billion valuation. But that’s going to come as little solace to anybody who bought Facebook shares in the past 16 months.

What’s more, I can easily see how the frothy Facebook valuations being seen on SecondMarket contributed to the debacle that was the Facebook IPO. Facebook executives with vested equity had the opportunity to sell their Facebook stock in early 2012 at valuations north of $80 billion; at the peak of Facebook fever, just before the IPO, the shares traded as high as $44 each. Given that Facebook was by far the most liquid stock on SecondMarket, and had weekly auctions from November 2010 onwards, it was pretty reasonable to consider SecondMarket to be a reliable price discovery mechanism.

What’s more, basic economic theory suggests that if a stock has buyers at $44 privately, then its public value will be higher than that, since the universe of potential buyers expands enormously. Given that theory, it would have been really hard, I think, for Morgan Stanley to price the IPO below the levels seen on SecondMarket for most of the previous year — a valuation of $80 billion or so.

In reality, however, it’s increasingly looking as though shares in private tech-companies are a bit like fine art prices: a place for the rich to spend lots of money and feel great about owning something very few other people can have. The minute they become public and democratic, they lose their cachet. And a lot of their value.

19 comments

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The mistake everyone makes is to confuse size with profitability. Yes, Facebook is huge. Yes, it has a lot of users. Yes, it is famous. But no, it does not generate a lot of profits. Too many people, especially amateur individual investors, are buying, the name, not the company.

And the problem for Facebook, just like it has been for many other internet companies, is to convert eyeballs into dollars. The problem for Facebook being that it has yet to come up with any other method for doing so other than targeted advertising/data mining, both of which degrade the user experience.

Posted by mfw13 | Report as abusive

“They can of course now short the stock, or buy puts, to try to protect their downside from here on out; that in turn is only going to further depress the price of the stock.”

So you’re saying FB is still over-priced, because shorts will only cause a stock to seek its true value, right?

I don’t think shorts will be required to bring FB’s market cap to a more appropriate level. Reality will do that all by itself.

Posted by KenG_CA | Report as abusive

“The mistake everyone makes is to confuse size with profitability. Yes, Facebook is huge…”

mfw13,

The most common error shared by the public, sophisticated investors, analysts and journalists, is thinking that fb has a billion users, and that a user is equivalent to “a person who uses fb”.

In fact, any person, or business can create any number of users (i.e. fictional identities, aliases)for themselves on fb, and many do so, for various reasons.
One person with 77 users (identities) on fb counts as 77 users, and a business who created 1,000 users in order to puff its fb presence counts as 1,000 users.
And fb users can’t be deleted – they are immortal…

Social media has always been prone to such puffing, to some extent, and fb seems to be a particularly fertile ground for that.

One billion users? – Try one order of magnitude less if you think ‘persons’, and two orders of magnitude less if you’re looking for people who actually use fb in the sense that they visit it regularly and spend considerable time on it.
And btw, many of these real users are kids and teenagers with little or no purchasing power.

I’ve been advertising online for years now, both on search engines and social / community websites, and I wouldn’t even consider advertising on fb.

Posted by reality-again | Report as abusive

It’s been pretty clear that the additional routes to getting paid pre-IPO (or pre-buyout) are part of the current bubble. As the previously guaranteed profits of pre-IPO rounds in famous companies dries up, where are the KPCBs of the world going to go for easy money?

I’m looking forward to watching the price of FB around lockup expiration. And the price of Peninsula real estate in the coming year.

Posted by AngryInCali | Report as abusive

Such a nicely reasoned piece, FS, until you get to this part –

“… basic economic theory suggests that if a stock has buyers at $44 privately, then its public value will be higher than that, since the universe of potential buyers expands enormously.”

News to me that the public is prohibited from playing in SecondMarket – ya’ learn something new (and wrong) every day, don’t ya’?

The IPO certainly did expand the number of shares in circulation. Now, what does “basic economic theory” say about increasing the actual supply of an item by many orders of magnitude, while increasing the pool of potential buyers maybe a little bit?

But hey, long as you get to the right destination –

“The minute they become public and democratic, they lose their cachet. And a lot of their value.” –

what difference does it make what route you traveled to get there?

Posted by MrRFox | Report as abusive

“And fb users can’t be deleted – they are immortal…”

Seriously? I have at least two accounts and haven’t touched either one in years. Wonder what proportion of the FB population are zombies?

Posted by TFF | Report as abusive

“what difference does it make what route you traveled to get there?”

Quite a bit. In the short term, the markets trade on momentum more than on value, IMHO.

Posted by TFF | Report as abusive

I wonder how many people like Mary Meeker actually use FaceBook, and think about how they would use it, whether people who spend all their time on FaceBook actually have a lot of purchasing power, and so on. Network broadcast companies, for instance, seem to know with something like precision who watches, in what demographics, and to what effect.

I have an FB account because a friend of mine asked me to open one. I look at it about once a week. It’s basically a bulletin board for keeping track of the milestones posted by my friends. The people I am really close to, including the friend who told me to sign up, almost never post there. I friended my sister and I have yet to see a single post from her. From my way of looking at things, FB is a declining use way station, because it just isn’t that appealing to read superficial nuggets posted by something less than bosom buddies (even as it seems to have chased away some other very appealing places that I used to inhabit).

Of course I could be wrong. One of my daughters posts a lot of stuff, but it’s not compelling enough to really keep everyone else interested for long. There is also a lot of manufactured content (games, etc.) that is superficially interesting until you realize it’s just a way of gathering information about people. But among my friends, the pattern seems to do that kind of stuff at first, and then stop altogether.

Anyway, the larger question is, do VC types actually interact with FB personally or do they just assume that the hype about users is true?

Posted by rb6 | Report as abusive

The FB app has no way of generating revenue… and most people use the app via mobile devices or update via a computer from time to time because the app is so limited. This is a HUGE strategic mess up that i just do not understand… who are the morons running the company?

Add to the fact that i have never clicked on a link on FB, and it’s never driven me to purchase anything, and i would doubt that many companies get decent revenue from it… And GM seems to agree with me there too…

I don’t get the valuation, and i don’t get how people think it’s worth even it’s current price… Based on the poor go forward strategy and the limited revenue opportunities, I recently passed an order at $5 per share. It will get there in not too long

Posted by GA_Chris | Report as abusive

reality-again, Facebook reminds me of Tom Lehrer’s (look him up) tune called “The Old Dope Peddler”, written circa 1948:

He gives the kids free samples, because he knows full well
That today’s young innocent faces, will be tomorrow’s clientele

Posted by Curmudgeon | Report as abusive

Above, MrRFox wrote: “News to me that the public is prohibited from playing in SecondMarket – ya’ learn something new (and wrong) every day, don’t ya’?”

MrRFox, Felix isn’t wrong, in the sense that in order to buy FB shares on SecondMarket, you had up until fairly recently (have?) to be an “accredited investor”, which is IRS lingo for “having a net worth of at least $1M US, not including the value of one’s primary residence or have made at least $200,000 each year for the last two years (or $300,000 together with his or her spouse if married) and have the expectation to make the same amount this year”.

I don’t think that its too far out to describe the set of folks outside that description as “the public”, since if you DID meet that criteria, then you could have just bought into facebook via a VC fund at Kleiner Perkins, Accel Partners or what have you.

Posted by Strych09 | Report as abusive

@Strych09 – I stand corrected. I was not aware of the prior(?) restriction of SecM access. This makes the whole thing seem even more bizarre. Felix characterizes them as “muppets” – so, that’s that on that – they’re muppets with net-worths greater and $1Mil. Hmmmm. They were pricing FB stuff at like $42+ right ahead of the IPO, right? Go figure.

Hey – you don’t suppose it’s possible that low-rent muppets are smarter than the Beverly Hills SecM crew, do ya’? That’s not even theoretically possible, is it?

Posted by MrRFox | Report as abusive

I think the “low rent” muppets are more likely to use FaceBook and understand how it actually works — as a personal (if not exactly private) space, not a public marketplace, much as it needs to be the latter if it is going to monetize itself. Apparently, it is Zuckerberg himself who made certain that FB would be distinguished from MySpace on this basis, because he understood that to do otherwise would turn off the masses. How exactly that knot will be untangled is, I guess, his chief responsibility as CEO.

In hard copy terms, if FB becoms the equivalent of the Penny Mailer, it’s hard to see how it will continue to have resonance with its user base. It’s already incredibly annoying to slog your way through the posts you have no interest in. Advertisers want to be intrusive, but if they are too intrusive then the forum stops being appealing and no one at all looks at it. That’s the main reason they all want to work through stealth means.

Anyway, I think it doesn’t make much sense to look so closely at the logistics of the IPO, who could buy in, when, on what terms etc. The real value of FB is over time if it can figure out the business issues, and I at least am extremely doubtful.

I also noted that not many seem to have analyzed this issue in terms of the documented drop off in individual investing generally. As a consumer kind of company, FB might have been expected to generate individual investor interest but that does not seem to have happened, so I see that as a pretty dour signal for the short-term future of individual stock investing.

Posted by rb6 | Report as abusive

@Rb6 – Your long-term analysis of FB’s prospects sounds good to me. Does seem like you might have missed the point a bit when it comes to the IPO thing, though.

Sometimes the right answer is the obvious one – The Beverly Hills muppets priced FB at $42+, and they and the insiders all thought the low-rent muppets would swallow the barbed-hook baited with “the FB story” even more passionately than the nouveau riche muppets had. They got double-crossed by the (surprisingly prudent) low-rent types. I’ll cry tomorrow.

Posted by MrRFox | Report as abusive

If anything, the Facebook IPO validated not how frothy the private markets are, but how broken the public markets have become. It is just another reminder of how impossible it is for retail investors to make money in the public markets when “growth” companies aren’t going public until they are very much “grown”. Stating that “Valuations in the private market are going to make it difficult to go public” is oxymoronic – companies simply cannot successfully IPO as a small cap anymore! Please read http://nowstreetjournal.com/2012/05/24/c oulda-woulda-shoulda-lessons-learned-fro m-facebooks-ipo/

Posted by NowStreet | Report as abusive

Zuckerberg wins. By billions!

Posted by uberimeifide | Report as abusive

“Zuckerberg wins. By billions!” (UberM)

Yes, he sure did – and muppets of all varieties now know what it feels lke to be a Winklevoss twit or one of his other IvyL victims. Speaking of which,

Brother Saverin surrendered his citizenship in Sept ’11, and from chart #1, FB had a value then of like $80B, as compared to like $60B now – and with his exit/capgain tax based on that first figure. Meaning, he paid tax on a higher value than he would have if he hadn’t fled the States. And he blew his citizenship to get the privelege to walk into that trap. So it’s true – every cloud does have a “silver lining”.

Posted by MrRFox | Report as abusive

Those who did not sell at the IPO can’t actually short the stock or buy puts as that would be a direct violation of the lock up agreement.

Posted by drdoolittle | Report as abusive

Amazingly, today, after such a long time has passed since the FB IPO, I read an article on Reuters in which the author said that FB was used by 900 million people, and Rob Cox, from Reuters, said a similar thing in a video…
Get real, please, and take the time to learn the difference between ‘users’ in the sense that facebook and other social media companies use the term, which just means ‘online entity’, and real people, who can each create hundreds of such (immortal) user entities for every site they use.
Examples:
Over the years, I’ve created numerous ‘user’ accounts on Reuters, but I’m still one guy.
I know people who use facebook who’ve created hundreds of ‘users’ over the years.
has anyone ever audited facebook in order to find the actual number of people (persons) who use it?
My guesstimate, based on 10 years of using social media and advertising on it, is that the end figure would fall between 1 and 2 orders of magnitude below the 900 million figure.

Posted by reality-again | Report as abusive