Inside the Facebook flop

A late decision to boost the number of shares hitting the market may have made it impossible for the share price to rise.

By RPrichard May 23, 2012 11:55AM

By The Wall Street Journal

 

Less than three days before Facebook’s ( FB) initial public offering, Chief Financial Officer The Wall Street JournalDavid Ebersman decided to boost the number of shares the company would offer investors by 25%, said people familiar with the planning. His main adviser at lead underwriter Morgan Stanley (MS) assured him there was plenty of demand, they said.

 

That decision by the 41-year-old Facebook executive may have doomed any real chance the social-networking company had that its stock would jump on its first day of trading -- a hallmark of successful IPOs.

 

On Tuesday, the second full day of trading, Facebook shares fell $3.03, or 8.9%, to $31, after falling 11% on Monday. Investors are blaming the downdraft on the last-moment expansion of the offering.

 

Securities and Exchange Commission Chairman Mary Schapiro said Tuesday that her agency will examine "issues" surrounding the IPO in an effort to ensure confidence in public markets. An SEC spokesman declined to elaborate.

 

Also on Tuesday, Nasdaq OMX Group said that if it had fully realized the extent of the technical problems that hampered the first day of trading it would have delayed the IPO.

 

Facebook's offering was one of the most widely anticipated in recent memory. In terms of the company's fundraising goals, it was a success. It raised $16 billion for Facebook and some early investors and valued the company at $104 billion.

 

Interviews with more than a dozen people involved in the IPO reveal that Facebook approached its deal differently than companies typically do. Ebersman kept a close grip on every important decision on the stock offering, not deferring to his bankers the way many companies do, according to the people familiar with planning.

 

Ebersman and his bankers saw eye-to-eye on key decisions, these people said. Michael Grimes, the co-head of global technology banking at Morgan Stanley, was his main confidant, they added.

 

"This IPO was an Ebersman and Grimes show," said one of the people familiar with the matter. "They were joined at the hip."

 

"I don't think an hour went by that they didn't talk" during the process, another person said.

 

Ebersman and Grimes both declined to comment.

 

Taking the lead

Facebook co-founder and CEO Mark Zuckerberg delegated the lead IPO role at the company to Ebersman, people familiar with the matter said. Chief Operating Officer Sheryl Sandberg recused herself from picking underwriters in part due to a personal friendship with Grimes, these people said.

 

The offering, the biggest ever for a U.S. Internet company, has thus far left many investors with losses. It remains to be seen whether that will matter to Facebook over the long term.

 

"Two moments from now, this moment won't matter," said David Sze, a partner at Greylock Partners, an early investor in Facebook, referring to the decline in the shares. "You don't build companies around speculators." He added, "I think people make their own decisions any time they buy stock. They may be proven incredibly fortuitous in the future."

 

The outcome has the potential to dent the reputation of Morgan Stanley, long considered the marquee bank for technology offerings. A person close to the matter said Morgan Stanley did what it was "paid to do" and that it "stood by the client and supported the issue."

 

Warning signs

Early in the offering process signs emerged that gave some investors pause. The company announced on April 23 that its revenue and profit had declined in the first quarter, from the fourth quarter of 2011. The news came two weeks before Facebook kicked off its "roadshow" on May 7 to pitch its shares to large investors. One week into the roadshow, the company raised its price range for the share sale, to between $34 and $38, from $28 to $35.

 

On May 15, The Wall Street Journal reported that General Motors (GM) planned to stop advertising with Facebook after deciding that paid ads on the site have little impact on consumers' car purchases. The move fueled questions about whether Facebook's business prospects could support its valuation.

 

Then came word that Facebook was expanding the deal by asking private investors to sell more shares. The decision to increase the number of shares had been under consideration since Mr. Ebersman began the IPO planning process more than a year ago, said one person familiar with the matter.

 

Ebersman had asked Facebook's early shareholders to fill out a form indicating how many shares they would like to sell in the IPO and at what price, and to indicate whether they would be willing to sell more if the share count was increased, the person said.

 

When Ebersman learned from Grimes that there was outsize investor demand, he went back to those forms and reached out to early shareholders to cash out more stock, the person said.

 

"This was a David decision," the person said, adding that it dovetailed with reports on demand.

 

Ebersman insisted that the lead three banks on the deal -- Morgan Stanley, J.P. Morgan Chase (JPM) and Goldman Sachs (GS) -- get regular and equal access to the so-called "book" showing investor orders, which generally was updated about every six hours during the roadshow, people familiar with the matter said. The people said these banks were also conferred with on major decisions, including the share price and deal size, those people said.

 

Other people said that while the banks were consulted, their influenced paled compared with Morgan Stanley's.

 

How hot was demand?

Demand on Tuesday night was "extreme," said one person familiar with the deal, saying more than 1,000 institutional investors had placed orders.

 

As word spread that the deal would be growing, investors got nervous that demand would be sated before the shares even began to trade. At the same time, some bankers felt ill-prepared to manage investors' questions about the change in size. Many learned of the growth in the deal's size after the change was filed Wednesday morning with regulators, according to people familiar with the matter. One person said decisions were kept close to the vest to prevent leaks.

 

Another person said that, after the disclosure, underwriters made "hundreds of calls" to investors explaining the move. "There may be those that questioned the decision, but no one was left in the dark," this person said, adding that orders for the more expensive shares remained strong after the increases.

 

By Thursday morning, there was one big decision left: the share price.

 

Early Thursday morning, Ebersman and Grimes talked on the phone and "directionally agreed" that the offer price should be $38 a share, said a person familiar with the call.

 

Soon after, Ebersman called bankers at J.P. Morgan and Goldman Sachs to get their opinions on the price, people familiar with the matter said. After some discussion, there was agreement about the $38, the people said.

 

Around 1:30 p.m. Eastern time, Facebook's "pricing committee" of board members dialed onto a conference call and were informed by Ebersman that he intended to go with a $38 share price, said a person familiar with the call. Nobody voiced objections and the call was quick, the person said.

 

Some underwriters wagered among themselves that shares would open around $41 or $42, people familiar with the matter said.

 

The shares did open around $42. "Good karma," one thought. Then shares promptly fell.

 

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