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
July 21, 2014 -- Updated 1235 GMT (2035 HKT)
Frida Ghitis: Anger over MH17 is growing against pro-Russia separatists. It's time for the Dutch government to lead, she writes
July 21, 2014 -- Updated 1227 GMT (2027 HKT)
Julian Zelizer says President Obama called inequality the "defining challenge" of our time but hasn't followed through.
July 21, 2014 -- Updated 1157 GMT (1957 HKT)
Gene Seymour says the 'Rockford Files' actor worked the persona of the principled coward, charming audiences on big and small screen for generations
July 21, 2014 -- Updated 1417 GMT (2217 HKT)
Daniel Treisman says that when the Russian leader tied his fate to the Ukraine separatists, he set the stage for his current risky predicament
July 18, 2014 -- Updated 1642 GMT (0042 HKT)
Andrew Kuchins says urgent diplomacy -- not sanctions -- is needed to de-escalate the conflict in Ukraine that helped lead to the downing of an airliner there.
July 19, 2014 -- Updated 0150 GMT (0950 HKT)
Jim Hall and Peter Goelz say there should be an immediate and thorough investigation into what happened to MH17.
July 18, 2014 -- Updated 1507 GMT (2307 HKT)
Pilot Bill Palmer says main defense commercial jets have against missiles is to avoid flying over conflict areas.
July 20, 2014 -- Updated 1755 GMT (0155 HKT)
Valerie Jarrett says that working women should not be discriminated against because they are pregnant.
July 21, 2014 -- Updated 1953 GMT (0353 HKT)
David Wheeler says the next time you get a difficult customer representative, think about recording the call.
July 18, 2014 -- Updated 1933 GMT (0333 HKT)
Newt Gingrich says the more dangerous the world becomes the more Obama hides in a fantasy world.
July 18, 2014 -- Updated 1011 GMT (1811 HKT)
Michael Desch: It's hard to see why anyone, including Russia and its local allies, would have intentionally targeted the Malaysian Airlines flight
July 17, 2014 -- Updated 1914 GMT (0314 HKT)
LZ Granderson says we must remember our visceral horror at the news of children killed in an airstrike on a Gaza beach next time our politicians talk of war
July 17, 2014 -- Updated 1206 GMT (2006 HKT)
Sally Kohn says now the House GOP wants to sue Obama for not implementing a law fast enough, a law they voted down 50 times, all reason has left the room.
July 17, 2014 -- Updated 1214 GMT (2014 HKT)
A street sign for Wall Street
Sens. Elizabeth Warren, John McCain and others want to scale back the "too big to fail" banks that put us at risk of another financial collapse.
July 17, 2014 -- Updated 2016 GMT (0416 HKT)
Newt Gingrich writes an open letter to Robert McDonald, the nominee to head the Veterans Administration.
July 18, 2014 -- Updated 1601 GMT (0001 HKT)
Paul Begala says Dick Cheney has caused an inordinate amount of damage yet continues in a relentless effort to revise the history of his failures.
July 18, 2014 -- Updated 1404 GMT (2204 HKT)
Kids who takes cell phones to bed are not sleeping, says Mel Robbins. Make them park their phones with the parents at night.
July 17, 2014 -- Updated 1729 GMT (0129 HKT)
Buzz Aldrin looked at planet Earth as he stood on talcum-like lunar dust 45 years ago. He thinks the next frontier should be Mars.
July 16, 2014 -- Updated 1804 GMT (0204 HKT)
Mark Zeller never thought my Afghan translator would save his life by killing two Taliban fighters who were about to kill him. The Taliban retaliated by placing him on the top of its kill list.
July 17, 2014 -- Updated 1518 GMT (2318 HKT)
Jeff Yang says an all-white cast of Asian characters in cartoonish costumes is racially offensive.
July 17, 2014 -- Updated 0124 GMT (0924 HKT)
Gary Ginsberg says the late John F. Kennedy Jr.'s reaction to an event in 1995 summed up his character
July 16, 2014 -- Updated 1641 GMT (0041 HKT)
Meg Urry says most falling space debris lands on the planet harmlessly and with no witnesses.
ADVERTISEMENT