Question of Fair Play Arise in Facebook’s I.P.O. Process from the NYTimes DealBook discusses how Morgan Stanley, Goldman Sachs, and other banks involved in the Facebook IPO “shared a negative outlook about Facebook with a select group of clients, rather than broadly with all investors.” In the days preceding the IPO the banks’ respective analysts lowered their estimates of Facebook’s growth after the company shared its quarterly and annual revenue projections.
As is typical in the I.P.O. process, research analysts at Morgan Stanley, Goldman Sachs and other firms contacted certain clients to discuss their revised expectations, while other big investors called on the banks to get their new take. But ordinary mom-and-pop investors did not have the same access to the valuable information.
The S.E.C. is investigating the Facebook IPO but what’s described above may not violate any laws: “research analysts are not obligated to share their work with the wider public. The rules governing the I.P.O. process allow analysts to confer with particular clients, as long as it is done in line with a bank’s longstanding policies.” Nevertheless, it shows how the game is rigged in favor of institutional investors, at retail investors’ expense.
I did not intend to post again about the Facebook IPO but Morgan Stanley’s $2.4 Billion Facebook Short persuaded me otherwise for its clear explanation of the Morgan Stanley greenshoe option, which involves shorting the IPO company’s stock. Felix Salmon explains how a greenshoe is supposed to work, the details of the Morgan Stanley Facebook greenshoe, and the circumstances under which the bank can make or lose money on it. Salmon concludes-
[s]o the chances are that at the end of the day, Morgan Stanley is going to end up pretty flat on its trade, selling the shares at $38 and then buying them back at $38. But if it bought more than 63 million shares on Friday, then it is sitting on a substantial mark-to-market loss right now. And similarly, if it bought back fewer than 63 million shares on Friday, then it’s actually making a profit on its greenshoe short.
(Thanks to WSH for sending the article’s link.)
Today’s first five stories from Eric Bedell’s This Web Day:
I don’t closely follow IPO’s, but I cannot remember the market and media turning on an initial public offering so quickly. Kicking the 800-pound billionaire gorilla may be entertaining, but this reaction bodes ill for other tech IPO’s in the pipeline.
Here’s an interesting tidbit from today’s NYTimes Dealbook article As Facebook’s Stock Struggles, Fingers Start Pointing:
Some institutional investors were also surprised by the size of their allocations, expecting to get far fewer shares. In the process of jockeying for I.P.O. shares, investors will typically ask for a large block, even if they expect to only receive a fraction.
“We got more shares than we expected, which spooked us,” said one portfolio manager, who spoke on the condition of anonymity for fear of upsetting Facebook’s underwriters. Concerned that the size of its allocation implied a lack of broad investor support, the manager sold all of the firm’s Facebook’s shares on Friday. “If it was truly a hot, hot deal, we would have gotten less.”
Some worthwhile analyses of why Facebook’s stock price has fallen below the float just a few days after the IPO:
- Roger Chen, CNET, Why Facebook’s stock is tanking–“Facebook just isn’t worth $100 billion . . . At $38, Facebook’s price-to-earnings ratio was more than four times that of Google’s 2011 PE ratio. That’s despite Google posting revenue and profit that were 10 times higher than Facebook . . . Apple trades at about 10 times its estimated earnings for next year, while Google has a price-to-earnings ratio of 12. Based on BTIG’s estimate and Business Insider’s own estimate, Facebook has a multiple of 40 to 100 times earnings.”
- MSNBC.com, After Facebook IPO debacle, finger-pointing begins—
- “Some pointed to underwriters offering too many shares, while others blamed an overly strong IPO price and worries about slowing revenue growth at the social network . . .
- Initial trading on the Nasdaq was delayed for half an hour due to issues with some orders . . . ‘This is arguably the worst performance by an exchange on an IPO — ever,’ said Thomas M. Joyce, chairman and chief executive officer of trading firm Knight Capital Group. ‘The failure was Nasdaq’s’ . . .
- [I]nvestment banks that arranged the offering overestimated the demand . . . ‘The late addition of 84 million shares to the offering overwhelmed demand, limiting the first day price’ . . .
- Robert Hof, Forbes, The Facebook IPO Was a Dud-Here are 3 Reasons it Matters–“[N]o pop at all the first day, besides a measly 23-cent rise–which only happened because Facebook’s underwriters bought millions of shares to keep it from going underwater? And today, a 9% 11% plunge? Can anyone really believe that’s in the best interests of Facebook, its employees, and its investors? . . . IPOs have always been a publicity event, and part of that publicity is at least a reasonable pop in the stock price the first day. A rational mind might wish it weren’t so, since that means money the company didn’t get, but that’s the reality of IPOs . . . So the perception of a blown IPO, even if it wasn’t blown in the financial sense, matters . . .
- It matters to Facebook employees . . . a flat to down stock price isn’t something that tends to keep the most ambitious people working long hours week after week.
- Prospective employees may look twice at working at Facebook.
- Valuations of other Internet companies just took a big hit.
The federal court in New York yesterday sentenced billionaire Raj Rajaratnam, founder of Galleon hedge fund, to 11 years in prison for insider trading. The 11-year sentence, while far less than the 24 years and 5 months sought by the prosecution, is the longest ever in an insider trading case in the U.S. This sentence is well-deserved, a sentiment that may appall my criminal-defense attorney son and former colleagues at the Prisoners’ Rights Project, but it is Rajaratnam’s naked dishonesty and greed, his fundamental corruption, that are appalling. Arguing for a lesser sentence one of his lawyers cited Rajaratnam’s charitable work, saying “Raj Rajaratnam has attempted to make the world a better place. If there is a ledger in one’s life, he should have some credit to draw upon in that ledger now that things have gone bad.”
Now that things have gone bad? This is not an appropriate situation to use the passive voice. Things did not go bad, like a bottle of milk left too long in the hot sun. Rajaratnam had education and wealth and affirmatively chose to be a criminal. He earned the shame and crushed reputation that are now his legacy.
A Freakonomics podcast about family-owned businesses reports that passing on control of the business to the next generation–what Freakonomics calls “Scionology”–generally diminishes value. It makes sense that passing control into a talent pool of limited size, whose members are determined by what Warren Buffet calls the “ovarian lottery,” would tend to yield less favorable results than merit-based succession to a larger and more diverse pool. This is true in all developed countries–except Japan. Why? Because “Japanese families often adopt an adult to take over.” 98%–98%!!!!–of Japanese adoptees are males between the ages of 25 and 30. Only 2% of Japanese adoptees are children.
LONDON—News Corp. founder Rupert Murdoch forcefully apologized to victims of phone hacking by his employees but declared he was not to blame—deflecting the responsibility for the fiasco to other managers, saying “they behaved dreadfully” and “it’s for them to pay.”
Murdochs Are Grilled, The Wall Street Journal, 19 Jul 11
Rupert Murdoch earned some $22.7 million last year as chairman of News Corp. His News Corp. stock is worth billions of dollars. What does that compensate him for, if not control and responsibility? How much more do those cost?
“Do you accept that ultimately you are responsible for this whole fiasco,” lawmaker Jim Sheridan asked.
“No,” Murdoch answered.
“You’re not responsible? Who is responsible?” Sheridan said, according to a Roll Call transcript.
“The people that I trusted to run [the tabloid], and then maybe the people that they trusted.”
When Murdoch was asked if he was guilty of “willful blindness” or ignoring “knowledge that you could have had and should have had,” he said: “We were not ever guilty of that.”
Murdoch’s Refusal to Take Responsibility May Undermine Credibility as CEO, Bloomberg, 20 Jul 11
As I write stories about Murdoch’s testimony before Parliament appear on the home pages of the Wall Street Journal, The New York Times, The Washington Post, The Boston Globe, The Hartford Courant . . . but not on News Corp.’s FoxNews.com.
The Journal’s article about the suit links to a great flash graphic titled “The Making of a Mortgage CDO.”
The SEC’s civil fraud suit against Goldman Sachs and Goldman employee Fabrice Tourre, filed yesterday in federal court in New York, alleges the defendants made “materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (“CDO”) GS&Co structured and marketed to investors.” The structured-investment’s value was tied to performance of a portfolio of subprime mortgages selected, according to Goldman’s marketing materials, by ACA Management. According to the Complaint Goldman failed to disclose to investors that hedge fund Paulson & Co., Inc. “played a significant role in the portfolio selection process” while maintaining “economic interests directly adverse to investors”–in other words, while shorting the portfolio. The SEC alleges Paulson entered into credit-default swaps with Goldman on specific tranches of the CDO. According to the complaint Tourre was responsible for structuring the investment, knew of Paulson’s undisclosed short interest, knew Paulson’s role in selecting the portfolio, and misled ACA that Paulson had a $200 million equity stake in the deal. Goldman earned $15 million in fees for structuring the investment. Six months after the April 2007 closing 83% of the portfolio’s mortgages had been downgraded; by January 2008 downgrades stood at 99%. The SEC alleges investors lost over $1 billion in the deal, while Paulson made over $1 billion. Goldman called the complaint’s allegations “completely unfounded” and claims its long position lost over $100 million.
The 22-page complaint crisply describes structured securities, synthetic CDOs, compromising internal correspondence, and this entertaining email from Tourre to a friend three months before the deal closed:
“More and more leverage in the system, The whole building is about to collapse anytime now. . . Only potential survivor, the fabulous Fab[rice Tourre]…standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”
In another email before the deal closed Fabulous Fab wrote “the cdo biz is dead we don’t have a lot of time left.” All together the complaint paints an ugly picture, but that’s what complaints do.
Why is Paulson not a defendant? Because Paulson did not communicate anything to investors. Investor disclosure, not deal structure, is the heart of the alleged fraud.