Who’s at Fault
Wall Street, Not Facebook, Bears Most of the Blame for the Company’s IPO Debacle
All the actors in the Facebook IPO debacle look bad, Zachary Karabell writes, but most of the blame should be directed at Morgan Stanley and the other banks that underwrote the stock offering. Plus, Dan Lyons breaks down 7 things to know about the scandal.
The saga of Facebook’s Wall Street debut continues. The latest twists are a series of investor lawsuits against the company’s underwriters—the investment banks who managed the process of issuing Facebook shares to the public market. The lead underwriter, Morgan Stanley, along with a familiar cast of others including Goldman Sachs and JPMorgan Chase, are accused of lowering both revenue and earnings forecasts for Facebook during the weeks leading up to the public debut without adequately emphasizing those facts when selling the shares.
At the same time, The Wall Street Journal has reported that Morgan Stanley and others have actually made in excess of $100 million since Friday when Facebook shares debuted and then plunged early this week. That $100 million is in addition to nearly $200 million in fees that the banks will collect, and comes from a typical part of the IPO process whereby the underwriters get to sell additional shares at the offering price and then buy them back if the stock goes lower, essentially shorting the stock and reaping the gains as part of their responsibility to attempt to maintain the price of the shares at something close to the offering price.
In terms of public relations, Facebook’s public debut has been a debacle. Every single actor in this particular drama is looking bad–the banks, the Nasdaq exchange that was overwhelmed by orders, and Facebook itself, including CEO Mark Zuckerberg, for his allegedly cavalier attitude about the price of the company and CFO David Ebersman for giving the green light in the days before the offering to up the number of shares and their price, thereby inflating the value of the company and possibly depressing demand for the shares once they started trading.
But public relations and media spin do not define reality—evidence to the contrary notwithstanding. Facebook has done many things right; going public it botched. John F. Kennedy famously said after the Bay of Pigs that victory has a thousand fathers but defeat is an orphan. Not in the case of Facebook’s public offering. There is blame to share, and it is now being duly apportioned. But selling shares and then seeing them sink on Wall Street is not the extent of Facebook’s business. Its business is connecting people, either for work or more often for play and diversion, but that is what it does. Whether it can generate consistent revenue based on advertising or yet-to-be-determined fees is still to be determined.
Selling shares is, however, one of the primary businesses of Wall Street investment firms, and if there was any doubt that these firms are overreaching and underperforming, the high-profile Facebook flub should lay them to rest. Morgan Stanley along with the rest of the syndicate badly misjudged demand, assumed that there would be a typical “New-Economy” surge in shares on the first day of trading, overpriced the deal by as much as 25 percent above what most thought was a reasonable opening price even a few weeks ago, and then issued even more shares. All of that was supported by Facebook’s senior management and thus by Zuckerberg. But Facebook’s management isn’t in the business of selling shares, and while Zuckerberg or his CFO could have overruled Morgan, the Wall Street syndicate was responsible for handling the offering and its failures fall squarely on their shoulders.
There are certainly those saying that the bungled offering shows that Facebook itself is a house of cards, a sign of a new New Economy bubble that has seen a variety of high-priced IPOs of popular but revenue-challenged companies go public at high valuation: Zynga, Pandora, and so on. But that is at the very least premature. Stock performance is not necessarily–or these days even usually—an indicator of corporate health or management acumen. Facebook’s shares sank below an offering price that was way too aggressive and is settling at about where it should have been before the process entered the maelstrom of Wall Street.
At every turn in the past four years, the financial industry has shown a stunning inability to adjust to a lower level of profit, higher levels of global risk, and a future where returns are likely to be modest. That problem is most acute in the high-profile finance titans, the investment banks that managed the Facebook deal. Between the mid-1980s and the mid-2000s, these firms accrued enormous profit and generated massive compensation packages. Since 2008 the story has been exactly reversed, except that compensation remains far more elevated than long-term profit would justify.
Bolstered by historical low interest rates and hence cheap money and infused with central bank support—and in 2008, actual bailouts—the financial industry avoided collapse. Unlike technology firms from 2000 to 2002, which nearly went bankrupt and were forced to change their spending and business models radically and rapidly, the financial industry is collectively clinging to dreams of a return to pre-2008. Hence the risks seen at JPMorgan Chase and its spectacularly failed hedging strategy, the collapse of MF Global, and this badly miscalculated Facebook deal. Those seemingly distinct blow-ups are actually part of a continuum: Wall Street is clinging to a model that no longer exists. Its business is shrinking; its appetites are not.
But these institutions cannot fight that reality forever. With each blow-up and each miscalculation, scrutiny intensifies and managers are forced to adjust. Slowly, these firms are taking less risk–though still too much relative to returns. Slowly, pay is decreasing–though still far too elevated compared to other industries. And slowly, Wall Street is becoming a less desirable place to work. No longer do the cream of the college crop dream of jobs at Goldman, and that is good thing—for them and for the financial world. There was actually a time, 30 and 40 years ago, when the financial world drew people who actually liked working in it, who enjoyed what they did and did what they enjoyed, and of course made money. Being drawn to a profession solely to make money is not a recipe for long-term viability.
Today, graduates want to work at the next Facebook, and the company’s current share price won’t change that one bit. Today, talented young people want to be in Silicon Valley or Silicon Alley or the next Hewlett-Packard garage. That is part of the Facebook allure, along with the dream of making the world a better place. And if they can get rich as well, why not? One day, just maybe, the same will be said of the financial world. Last week, the two worlds met, and it wasn’t a happy meeting. Facebook has a lot to learn and much to prove, but not nearly as much as Wall Street.