Here’s How Facebook’s Competing Factions Created a Masterful Mess

Everyone is focused on how Morgan Stanley (NYSE:MS), Goldman Sachs (NYSE:GS) and the Nasdaq (NASDAQ:NDAQ) botched Facebook’s (NASDAQ:FB) IPO. However, the magnanimous mess started long ago by what Thomas Jefferson loved to call competing factions.

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In the beginning, former Facebook employees wanted what every equity holder wants: an exit. So, these bright toilers sought out a marketplace to turn their shares into cold hard cash. This ignited a chain of events where the cap table was broken and the once monolithic group “Facebook shareholders” no longer controlled who bought stock and what they planned to do with it.

Enter SecondMarket et al. Second Market didn’t give a sh*t about Facebook (NASDAQ:FB) shareholders. They are simply in the business of helping one person sell a widget to another. The more widgets transacted, the more money they make. So, SecondMarket (and their competitors) pushed and marketed Facebook shares like tax prep services during tax season. Now, Facebook had the classic principal-agent problem where the agent’s interests where not aligned with the principal. Oy!

Here come the … speculators en mass! Here’s where the story hits the real fork in the road and different shareholders took different paths. Prior to Facebook (NASDAQ:FB) shares trading on the private market, at least employees and early direct investors had more stable and predictable intentions and goals as shareholders. However, once employees offloaded shares to speculators, an entire new layer of demand for shares was created, thus increasing stock value as a result of hype and pure lust. It’s important to note, prior to this point, Facebook had to have some realistic internal valuation on their shares which had to be supported by financial fundamentals. However, once the speculators arrived, shares were “unpegged” from fundamentals and inflated as fast as demand allowed. And then you had speculators pumping and dumping to more speculators, who were pumping and dumping, and so on.

Then, the founders were forced to IPO to take advantage of the nose-bleed valuation. Mark Zuckerberg and his C-Suite pals are smart. They know user growth is going to plateau once you have almost 1 billion users. And once that trend sets in for enough quarters, the valuation multiple beings that super fun phase called contraction. Given that pre-IPO investors were willing to pony up 14x revenues at $38 a share, FB execs knew if that valuation slipped back to a reality such as Google’s 7x revenues IPO pricing, they’d either have to 2x revenues or 2x users to be worth the same amount of money. That’s a lot of work for the same exact amount of money. So, logic got the best of them and they called their …

Investment bankers. These agents have all the same incentives as SecondMarket, except they have all sorts of century old scams and tricks to deploy when companies are super hot like Facebook. They also don’t care to wait for Zuckerberg to figure out how to double his revenues or user base (which may not even be possible). They saw rocket high multiples and knew it was time to jam the merchandise down the throats of the same people they always screw:

The general public. Investment bankers work for their clients. Not the general public or buyers of the stock. Their sole job is to get the absolute highest possible price for their client. And when they call you to let you know about something “big” you “must have”, that means most of the upside has been sucked out — otherwise they’d be buying shares themselves rather than telling you about it. And in this case, we’re now learning Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS) admitted to select clients the shares were overvalued pre-IPO. But that didn’t stop them from selling those overvalued shares to public investors because their job isn’t to be fair, only get their clients the best deal possible.

There’s your mess. A bunch of different people with completely different incentives and ways of making money from the same paper.

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