Skip to main content

Was Facebook's botched IPO a conspiracy?

By Aswath Damodaran, Special to CNN
May 28, 2012 -- Updated 1551 GMT (2351 HKT)
Facebook shares traded up initially when the company went public on May 18.
Facebook shares traded up initially when the company went public on May 18.
STORY HIGHLIGHTS
  • A week into Facebook's debut on the market, its price was down
  • Aswath Damodaran: Facebook's IPO debacle was result of ineptitude
  • Damodaran: Don't assume that bankers and experts know what they are talking about

Editor's note: Aswath Damodaran is the Kerschner Family Chair professor of finance at the Stern School of Business at New York University. He is the author of four books about valuation, including "The Dark Side of Valuation."

(CNN) -- A week into Facebook's debut on the Nasdaq stock exchange, its initial offering price of $38 per share dropped to $31.91. Retail investors' fears deepened as they realize they are losing a lot of money.

The Facebook IPO did not follow the usual script. Instead of launching the largest social media company in the world as a legitimate and valuable business, the IPO has laid bare all of the questions and doubts about its potential performance.

So why did the Facebook IPO bomb as badly as it did?

Aswath Damodaran
Aswath Damodaran

In a lawsuit filed last week, some investors contend that Morgan Stanley, the lead underwriter of the IPO, withheld key information about a negative financial forecast from them while sharing it with their institutional clients.

In this conspiratorial tale, the bad guys are the insiders at Facebook, the investment bankers and the favored institutional clients of these bankers. The bankers set the offering price at $38, knowing that the stock was not worth that much, the insiders in the company unloaded their shares at the offering price and institutional investors stayed on the sidelines. Individual small investors who bought at the offering price suffered as the price collapsed. In other words, the suckers are the rest of the world.

Opinion: Was Facebook IPO a bust?

Deconstructing the Facebook IPO mess
Media to blame for Facebook IPO issues?
Why is Facebook being sued?

But I don't buy this story. First, unlike many others who have seen the crises of the last few years as evidence that bankers are evil, I see them more as inept. Facebook's IPO is just proof that if you want something valued, you should not ask a bank to do it.

None of the actors in this story can be happy with how Facebook's IPO has unfolded in its first week. The investment banks look like bad "deal makers," which strikes at the heart of one of their few remaining revenue-generating skills. Any profits or commissions that Morgan Stanley booked on this IPO are overwhelmed by the reputation hit that it took and the consequences this will have on future deals. The Facebook insiders who remain have not only lost billions in value but have made it more difficult to unload their remaining shares down the road. And most of the shares at the offering price went to the institutional investors, who now face paper or real losses on those shares.

Facebook IPO: Outraged investor cries grow louder

So, what happened?

I think the investment bankers priced the offering based on how shares of Facebook were trading in the private market and their assessments of institutional demand. I don't think that revenue growth, margins, risk or any other fundamentals played much of a role in the pricing. I don't fault them for playing the momentum game, but they played it badly.

By pushing up the offering price to its upper limit and by expanding the offering to allow more insiders to cash out, they broke the spell that momentum casts over investors. It would have happened eventually, but they did not anticipate how quickly the shift would occur.

What are the lessons to take from this mess?

First, don't assume that bankers, experts and analysts know what they are talking about. When they tout an investment, be especially skeptical if they have a stake in it.

Reactions: Facebook IPO underwhelms Web, too

Second, much as it soothes the ego to think that your portfolio setbacks are because of a conspiracy, where large institutional clients make a killing and the individual investors get the crumbs from the table, it is institutional clients who lose the most in bad deals because they have more to lose.

Finally, remember that markets make mistakes, and they can make bigger ones after a meltdown like this one. I would not be surprised if disappointed investors drive the price down to a point where you and I can have the ultimate revenge on Mark Zuckerberg: Buy his company at a bargain basement price and make money off him.

Follow us on Twitter @CNNOpinion

Join us on Facebook/CNNOpinion

The opinions expressed in this commentary are solely those of Aswath Damodaran.

ADVERTISEMENT
Part of complete coverage on
September 20, 2014 -- Updated 1624 GMT (0024 HKT)
John Sutter boarded a leaky oyster boat in Connecticut with a captain who can't swim as he set off to get world leaders to act on climate change
September 19, 2014 -- Updated 2322 GMT (0722 HKT)
Is ballet dying? CNN spoke with Isabella Boylston, a principal dancer at the American Ballet Theatre, about the future of the art form.
September 19, 2014 -- Updated 2147 GMT (0547 HKT)
Sally Kohn says it's time we take climate change as seriously as we do warfare in the Middle East
September 19, 2014 -- Updated 1302 GMT (2102 HKT)
Dean Obeidallah says an Oklahoma state representative's hateful remarks were rightfully condemned by religious leaders..
September 19, 2014 -- Updated 1922 GMT (0322 HKT)
No matter how much planning has gone into U.S. military plans to counter the Islamic State in Iraq and Syria, the Arab public isn't convinced that anything will change, says Geneive Abdo
September 19, 2014 -- Updated 1544 GMT (2344 HKT)
President Obama's strategy for destroying ISIS seems to depend on a volley of air strikes. That won't be enough, says Haider Mullick.
September 19, 2014 -- Updated 1303 GMT (2103 HKT)
Paul Begala says Hillary Clinton has plenty of good reasons not to jump into the 2016 race now
September 19, 2014 -- Updated 1501 GMT (2301 HKT)
Scotland decided to trust its 16-year-olds to vote in the biggest question in its history. Americans, in contrast, don't even trust theirs to help pick the county sheriff. Who's right?
September 19, 2014 -- Updated 0157 GMT (0957 HKT)
Ruben Navarrette says spanking is an acceptable form of disciplining a child, as long as you follow the rules.
September 19, 2014 -- Updated 1547 GMT (2347 HKT)
Frida Ghitis says the foiled Australian plot shows ISIS is working diligently to taunt the U.S. and its allies.
September 19, 2014 -- Updated 1958 GMT (0358 HKT)
Young U.S. voters by and large just do not see the midterm elections offering legitimate choices because, in their eyes, Congress has proven to be largely ineffectual, and worse uncaring, argues John Della Volpe
September 19, 2014 -- Updated 0158 GMT (0958 HKT)
Steven Holmes says spanking, a practice that is ingrained in our culture, accomplishes nothing positive and causes harm.
September 18, 2014 -- Updated 1831 GMT (0231 HKT)
Sally Kohn says America tried "Cowboy Adventurism" as a foreign policy strategy; it failed. So why try it again?
September 18, 2014 -- Updated 1427 GMT (2227 HKT)
Van Jones says the video of John Crawford III, who was shot by a police officer in Walmart, should be released.
September 18, 2014 -- Updated 1448 GMT (2248 HKT)
NASA will need to embrace new entrants and promote a lot more competition in future, argues Newt Gingrich.
September 16, 2014 -- Updated 2315 GMT (0715 HKT)
If U.S. wants to see real change in Iraq and Syria, it will have to empower moderate forces, says Fouad Siniora.
September 18, 2014 -- Updated 0034 GMT (0834 HKT)
Mark O'Mara says there are basic rules to follow when interacting with law enforcement: respect their authority.
September 16, 2014 -- Updated 1305 GMT (2105 HKT)
LZ Granderson says Congress has rebuked the NFL on domestic violence issue, but why not a federal judge?
September 16, 2014 -- Updated 1149 GMT (1949 HKT)
Mel Robbins says the only person you can legally hit in the United States is a child. That's wrong.
September 15, 2014 -- Updated 1723 GMT (0123 HKT)
Eric Liu says seeing many friends fight so hard for same-sex marriage rights made him appreciate marriage.
ADVERTISEMENT