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.

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