Skip to main content

Was Facebook's botched IPO a conspiracy?

By Aswath Damodaran, Special to CNN
updated 11:51 AM EDT, Mon May 28, 2012
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
updated 6:03 PM EDT, Tue August 19, 2014
It used to be billy clubs, fire hoses and snarling German shepherds. Now it's armored personnel carriers and flash-bang grenades, writes Kara Dansky.
updated 1:27 PM EDT, Wed August 20, 2014
Maria Haberfeld: People who are unfamiliar with police work can reasonably ask, why was an unarmed man shot so many times, and why was deadly force used at all?
updated 5:52 PM EDT, Mon August 18, 2014
Ruben Navarrette notes that this fall, minority students will outnumber white students at America's public schools.
updated 5:21 PM EDT, Tue August 19, 2014
Humans have driven to extinction four marine mammal species in modern times. As you read this, we are on the brink of losing the fifth, write three experts.
updated 7:58 AM EDT, Tue August 19, 2014
It's been ten days since Michael Brown was killed, and his family is still waiting for information from investigators about what happened to their young man, writes Mel Robbins
updated 1:23 PM EDT, Wed August 20, 2014
Sally Kohn says the Ferguson protests reflect broader patterns of racial injustice across the country, from chronic police violence and abuse against black men to the persistent economic and social exclusion of communities of color.
updated 8:42 AM EDT, Mon August 18, 2014
The former U.K. prime minister and current U.N. envoy says there are 500 days left to fulfill the Millennium Goals' promise to children.
updated 9:10 AM EDT, Mon August 18, 2014
Julian Zelizer says the left mistrusts Clinton but there are ways she can win support from liberals in 2016
updated 1:38 PM EDT, Wed August 20, 2014
Peter Bergen says the terror group is a huge threat in Iraq but only a potential one in the U.S.
updated 1:34 PM EDT, Sat August 16, 2014
Mark O'Mara says the way cops, media, politicians and protesters have behaved since Michael Brown's shooting shows not all the right people have learned the right lessons
updated 11:23 AM EDT, Sun August 17, 2014
Retired Lt. Gen. Mark Hertling says the American military advisers in Iraq are sizing up what needs to be done and recommending accordingly
updated 3:41 PM EDT, Fri August 15, 2014
Marc Lamont Hill says the President's comments on the Michael Brown shooting ignored its racial implications
updated 5:46 PM EDT, Fri August 15, 2014
Joe Stork says the catastrophe in northern Iraq continues, even though many religious minorities have fled to safety: ISIS forces -- intent on purging them -- still control the area where they lived
updated 6:26 PM EDT, Thu August 14, 2014
Tim Lynch says Pentagon's policy of doling out military weapons to police forces is misguided and dangerous.
updated 9:15 AM EDT, Fri August 15, 2014
S.E. Cupp says millennials want big ideas and rapid change; she talks to one of their number who serves in Congress
updated 7:57 PM EDT, Thu August 14, 2014
Dorothy Brown says the power structure is dominated by whites in a town that is 68% black. Elected officials who sat by silently as chaos erupted after Michael Brown shooting should be voted out of office
updated 7:49 AM EDT, Thu August 14, 2014
Bill Schmitz says the media and other adults should never explain suicide as a means of escaping pain. Robin Williams' tragic death offers a chance to educate about prevention
updated 11:05 AM EDT, Fri August 15, 2014
Nafees Syed says President Obama should renew the quest to eliminate bias in the criminal justice system
updated 4:24 PM EDT, Thu August 14, 2014
Eric Liu says what's unfolded in the Missouri town is a shocking violation of American constitutional rights and should be a wake-up call to all
updated 3:22 PM EDT, Wed August 13, 2014
Neal Gabler says Lauren Bacall, a talent in her own right, will be defined by her marriage with the great actor Humphrey Bogart
updated 6:56 AM EDT, Fri August 15, 2014
Bob Butler says the arrest of two journalists covering the Ferguson story is alarming
updated 4:35 PM EDT, Wed August 13, 2014
Mark O'Mara says we all need to work together to make sure the tension between police and African-Americans doesn't result in more tragedies
updated 4:06 PM EDT, Mon August 18, 2014
Pepper Schwartz asks why young women are so entranced with Kardashian, who's putting together a 352-page book of selfies
updated 7:08 PM EDT, Wed August 13, 2014
Michael Friedman says depression does not discriminate, cannot be bargained with and shows no mercy.
updated 11:25 AM EDT, Tue August 12, 2014
LZ Granderson says we must not surrender to apathy about the injustice faced by African Americans
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT