Saturday, May 21, 2011

The Joke Will Be on Facebook Investors

Reid Hoffoman, one of the most sophisticated Internet investors in the nation, a major investor in Facebook and a principal in LinkedIn, took LinkedIn public. The outcome resembled some of the rip-offs of the first Internet boom, with the initial offering price of LinkedIn being far below its "market value" at the end of the day, and Joe Nocera is concered that LinkedIn may have been scammed.
The company had hired Morgan Stanley and Bank of America’s Merrill Lynch division to manage the I.P.O. process. After gauging market demand — which is what they’re paid to do — the investment bankers priced the shares at $45. The 7.84 million shares it sold raised $352 million for the company. For this, the bankers were paid 7 percent of the deal as their fee.... When LinkedIn’s shares started trading on the New York Stock Exchange, they opened not at $45, or anywhere near it. The opening price was $83 a share, some 84 percent higher than the I.P.O. price. By the time the clock had struck noon, the stock had vaulted to more than $120 a share, before settling down to $94.25 at the market’s close. The first-day gain was close to 110 percent....

The fact that the stock more than doubled on its first day of trading — something the investment bankers, with their fingers on the pulse of the market, absolutely must have known would happen — means that hundreds of millions of additional dollars that should have gone to LinkedIn wound up in the hands of investors that Morgan Stanley and Merrill Lynch wanted to do favors for. Most of those investors, I guarantee, sold the stock during the morning run-up. It’s the easiest money you can make on Wall Street.
Yes, it's a sweet way for insiders to make a quick buck. But the fact that LinkedIn could have raised more money doesn't mean that its insiders sold at $45 per share. And the low price will help major shareholders of Facebook reap huge profits if investors anticipate a similar run-up in price.

There's also a legitimate question of whether it's the job of the investment bank to value the company (even with a premium for investor hubris) at a value that has nothing to do with it's actual or potential fair market value, under the assumption that an appreciable number of investors are ready to repeat their experience investing in sites like A company that made $16 million in profits last year producing, as best as I can see, a torrent of email notices that most members delete unread, now has a market capitalization of $8.8 billion dollars - and that valuation is significantly lower than its peak. Let's say it experiences 100% growth in profits, each and every year, for the next... century? Seriously, how is that valuation even slightly realistic? Facebook is reported to have earned between $400 and $500 million in profits last year with what, by all appearances, is a considerably more viable model for growth - should we expect it to have a market capitalization of $220 to $250 billion?

Really, I think this was less about LinkedIn being cheated and more about setting up the next round of suckers in the "social network IPO" scheme. I recognize that some people say that the LinkedIn IPO won't affect the timing of a Facebook IPO, and (yes) among them are many who care far more than I about the markets and investment, but I suspect otherwise. When you see this much investor hubris, this much disregard of profitability, this much willingness to gamble, you would be pretty foolish to sit on your hands. Realistically speaking, LinkedIn is going to continue to decline in value, and you'll be wanting to get your own shares sold before investors start to association that deflation with the value of social networks in general.

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