Swanberg 1 Brent Swanberg 4/7/2013 Bain-Conkin Research Paper Liking Facebooks IPO Facebook has grown to 1 billion users

as of December 2012 and has 1.06 billion currently in 2013 (facebook.com). This makes Facebook the largest social networking site on the internet. The founder of Facebook, Mark Zuckerberg, created the site in his dorm room at Harvard University. Although initially for use by only Harvard students, the site quickly expanded to Boston-area colleges, Ivy League Schools, and Stanford University. The rest is history. Facebook then exploded into the internet sensation it is today. With over 600 million people accessing Facebook on any given day (Vejacka, 1) and a movie based on its creation, it isnt hard to see how wildly successful this company has become. So successful, in fact, that many people clamored for the social networking giant to offer shares of the company to the investing public. So on May 18th, 2012 Facebook offered its IPO at $38 dollars per share. But, what was once expected to be an incredibly successful and profitable IPO turned into the worst IPO flop of the decade according to Sheila Dharmarain of Bloomberg BusinessWeek. But was this IPO really a failure as most experts like to believe? Although some believe that the Facebook IPO was a failure, it was not the Facebook IPO that flopped at all. To fully understand this claim we must understand both why the IPO did not do as well as most people expected and what caused the IPO to fail. Even before we do that we must start at the basics. What is an IPO? An IPO simply stands for and Initial Public Offering. This is when a company decides to open their company up to the general public through the sale of stocks. The benefit to selling these stocks is

Swanberg 2 the huge amounts of capital a company can gain. The capital gains allow businesses to expand operations, finance new projects, or just start up their business (Brutton, 4). However, it is hard for a company to evaluate themselves without bias. This is why most companies have investment banking firms evaluate their companies. This is called underwriting. Companies strategically select investment banks to underwrite their IPOs. One reason is because they are trusted by investors. These investors will, in turn, have more confidence in investing in a company. Another reason is that they take advantage of the economies of scale in their business and bring companies stock to the markets with exposure that currently cannot be duplicated by individual firms without substantial expense (Brutton 6). Basically, it is cheaper for companies to have an investment bank underwrite their IPO. These investment banking firms will announce an IPO price below the actual worth of the stock. Dr. Gary Brutton supports this as the reason IPOs make so much when he states, If we assume that the market price of the stock, dictated by supply and demand, is representative of the companys value, then the large gain reflects the fact that the IPO issuing price agreed upon by the underwriter and the firm making the offer is under the actual value of the firm (6).This underpricing allows for the huge gains IPOs normally get because investors initially jump on low prices all at once. As soon as each investor sees how dramatically the stock is rising it prompts confidence and interest in the investment itself. In this way, IPOs are the quickest ways for a company to make fast capital. However, people will only invest when they know they will get a return on their investment. In other words, a company must make enough money to pay the shareholders their dividends. So why is it that so many people initially wanted to invest in an internet company that offers a free service? Facebook, although free to use, does in fact make revenue. In order to make money, Facebook utilizes advertising and company alliances. It is no secret that Facebook advertises. The ads we are interested in are the ones that appear on the right hand side of the browser. These ads are specifically

Swanberg 3 tailored to each individual Facebook user. Once a user creates a profile they put information about themselves out publically. Because this information is public, Facebook feels as though they can offer this information to companies who will pay for it. Initially, companies are interested in interest and likes of Facebook users. Users will like pages or voice their interest in topics by sharing photos or videos, liking certain pages, listing activities they enjoy, updating their statuses, and attending groups (Vejacka, 118). Companies also benefit from knowing users demographics. Age, gender, relationship status, and preferred language are all valuable to companies (Vejacka, 119). Knowledge of education and work can allow companies to advertise to people who attend a specific school or work at a particular company (Vejacka, 119). Users location can be important to companies looking to advertise to a target market within a certain country, province, city, or target radius. These users can tag their current location in posts, offer profile information about their location, or show where they are located based on their IP address (Vejacka, 119). All of this information is collected and distributed to advertisers who create personalized ads for users based on what will appeal to them the most. Such specialized ads lead to highly efficient advertisements because Facebook users are more likely to click on the ad and even more likely to purchase and advertised good after that initial click. This is why Facebook advertising is coveted by companies. But how does Facebook make any money off of this? Vejacka comments on how Facebook will make money when he writes Advertisements on Facebook are subject to auction, where advertisers compete among themselves for an audition through bidding the price of click on their ad (pay per click) or the price of displaying their ad to selected target group (pay per impression) (Vejacka, 118). Facebook will earn money Vis--vis how many users click on their advertisement. According to Jeff Robertson, Facebook earns about 82% of its revenue by these means, and 6% of revenue comes from its virtual gifts. The other 12% comes from Facebooks alliance with the gaming website Zynga (Winkler, 1). Zynga has produced social games such as: Mafia Wars, Farmville, and Words With Friends. There are

Swanberg 4 very straightforward ways these two companies earn money as Winkler explains in his article, First, it pays Facebook to advertise its games. Second, it pays Facebook a cut of revenue it generates on Facebook's platform (Winkler, 1). More specifically, Shayndi Raice stated that Facebook began requiring Zynga to pay 30% of its revenue from the sale of virtual goods on the social network(4). However, these companies help each other beyond this direct exchange of funds. Zynga allows easier membership to Facebook users by allowing them to log in using only their Facebook login. Facebook allows its users to play certain Zynga games directly from Facebook. This increases internet traffic for both sites. For Facebook, that means more people are exposed to advertising which leads to more ad revenue. For Zynga, that means more people are exposed to their addicting games and may love the games so much that they are compelled to purchase in game add-ons (the main source of Zyngas revenue). When this internet giant announced it was going public, there were incredibly high expectations for the stock. These expectations were mostly based on the price of the IPO, comparisons to other internet companies, and Facebooks potential. When Facebook announced its IPO, the price was set at $38 dollars a share. Times: International Business explains that, at this price, the underwriting banks evaluation of Facebooks worth was $104 billion when they only earned $3.7 billion in revenues the year before the IPO (1). Therefore, the investment banks over-evaluated their company by $100 billion. This made Facebook the largest internet IPO ever. Of course people had high expectations for Facebooks IPO with an evaluation like that. These impressive statistics are what created this stigma that Facebooks IPO must be wildly successful in order for it not to be a flop. People also compared Facebook to other internet companies. Gordon Platt explains in his informative article Waiting For Facebook, IPO Market Revives that much of the Facebook hype came out of a Chinese social-networking site, Renren. Gordon informs that, Renren was the largest IPO in the Asia-Pacific region last year, raising approximately $855 million on NYSE Euronext (1). The investing

Swanberg 5 public, knowing that Facebook was larger and more successful than the Chinese social-network site, assumed that the stock would do very well if Facebook decided to go public. Even some socialnetworking internet IPOs in the United States had some success. But Internet IPOs have had mixed success. Daily deals website Groupon Inc. has lost about 35% of its value since its Nov. 4 debut, while stock at professional network LinkedIn Corp. has gained nearly 150% since it started trading (Raice and Light, 6). Groupon is a site that offers a product of some economic importance: coupons. LinkedIn, on the other hand, is simply a social networking site so making job connections. Here we see that this free service provided by this social-networking site had more capital gains from their IPO than an internet company that could make some serious profits off of its service that it provides (a serious concern of investors). Investors would immediately conjure up fantastic speculations of how a similar, yet more popular, social-networking site like Facebook could do in the public market.

Most people would claim that the Facebook IPO was a failure. In fact, most would assert that the extreme drop in the value of the stock suggests its failure. It is not secret that the Facebook IPO dropped from $38 to $31 on the first day alone (see graph above, Yahoo Finance). The stock then

Swanberg 6 continued to drop to roughly $16. Statistically speaking the physical initial offering of the stock did not do as well as thought. So by definition, the Facebook IPO was a failure. However, if there was neither an extreme over-evaluation, nor impressive expectations for the hype then this IPO would not be considered a failure. Facebooks IPO stock was too overpriced, and that is the reason behind the IPOs sharp decline. The over-evaluation by those who underwrote the IPO was a result of them being selfish. There were several banks who underwrote this IPO (Morgan Stanley, Goldman Sachs, Barclays, Bank of AmericaMerrill Lynch, and JPMorgan) and they all wanted the same thing. Wigan explains the folly of the banks when he says It was planned and allocated poorly. In fact, Morgan Stanley and other banks might have acted unethically, trying to use their power to simply squeeze every cent out of the IPO. Meanwhile, early-stage investor Goldman Sachs increased the number of shares it planned to sell at the IPO by 25% (4). Basically, these banks raised the price of the IPO to its max. Then, they offered as many stocks as they could to, potentially, increase the volume of stock sales. This explains the $100 billion overevaluation. In the words of Chicago-based securities lawyer Andrew Stoltmann, "Ultimately the banks are the bad actor in this entire soap opera. Morgan Stanley knew what it was doing - it maxed out the price and share allocation" (Wigan, 5). There was no way that the IPO could survive at such a high offering. Investors were unsure of this price, and not enough investors wanted to buy this stock at such a high price. Facebook had nothing to do with this failure. Essentially, this was not a Facebook IPO failure, this was an investment bank IPO failure. Had the stock opened at a lower price, then the stock would have acted like an IPO should (sharply increasing in value and attracting investors) as previously explained. The hype surrounding the stock, as a suggested earlier, created this notion that the Facebook IPO had to be wildly successful or else it would be a failure. People are simply too critical about the success of an internet IPO. The authors of What Determines The Survival Of Internet IPOs? acknowledge

Swanberg 7 the risks of internet IPOs when they argue, It appears that the average operating history of internet IPOs is remarkably small compared to non-internet IPOs, namely 2.4 and 10 years, respectively. Furthermore, we find that the average number of risk factors for internet IPOs is four times higher than the number reported for non-internet IPOs(van der Goot, Tjalling, van Giersbergen, Botman, 2). Internet IPOs are simply newer and inherently more risky. To compare the success of an internet company that provides a free service to a multi-billion dollar corporation that sells a good would be ridiculous because the complexities of their respective markets are in no way similar. The internet IPO is incredibly more difficult to get right because it relies more on investment strategy and gaining investor confidence. As a result, by the standards of internet companies, Facebook has done very well. Another reason that the IPO did not do as well as expected on the first day was due to a technical glitch. David Wigan explained that within first couple minutes of trading the IPO stock there was a glitch would not let anyone trade the stock. Wigan claims it had effects on the IPO, GM backing out of Facebooks advertising deal and the change of price before opening that caused public confusion and insecurity with Facebooks IPO (Wigan, 1). GM got nervous because they had no idea what was happening. Neither did the investing public. Thus, no one invested, and that is how we got the big initial drop in stock value. Everything snowballed from here. Other investors saw that initial drop as a sign of weakness in the stock and chose not to invest. Also, investors saw the corporate giant GM backing out as a sign of weakness in Facebook. As a result, other investors got nervous and didnt invest. This is why the huge drop in stock price occurred. If the technology would have executed as it was supposed, to the IPO would have completely different results and would probably not have been considered a failure. After things settled down, though, we see a consistent increase in the value of the stock. The true worth of a stock is measured over time. As we see in the graph provided by Yahoo Finance, Facebooks stock continues to grow. It is absurd to claim that the IPO was a failure because the stock has been slowly climbing up in value toward what the stock was initially valued at. In this light, the decision

Swanberg 8 to release an IPO was a successful action by Facebook. The Forbes reporter Connie Guglielmo put it this way: They sold stock at a very high level because there was demand for itThey raised a ton of cash. The fact that speculators bought Facebook's shares at a high level because it was inflated and found there was no demand behind the demand doesn't mean the IPO should be deemed a failure (1). This is exactly right. Facebook made a lot of money from their IPO. In fact, gaining capital is the reason behind offering and IPO. It could even be said that it is the goal of an IPO. Facebook achieved that goal, and achievement is not failure.

Any stock ultimately reflects its companys progress. Although the stock may have initially flopped, it would be incorrect to say that it was a failure because the company behind it is not a failure. In fact it is quite successful. Look at Michael Cusumanos chart (above) on page 22 of his article depicting how Facebook stacks up on paper compared to the other top internet companies who have gone public. Facebook is easily comparable to these internet companies who were deemed to have successful IPOs. Their gross margin, or difference between revenue and costs, is one of the best among these companies and so is its sales growth. Both of these statistics suggest growing and thriving company. It would be hard to believe that Facebooks IPO could be called a failure when the data suggests the company will still be growing in success.

Swanberg 9 Many people might see the initial drop in price of Facebooks IPO as a failure. But the true worth of a stock is the overall success and growth of a company. Some companies have been completely driven out of business by their IPO, but Facebook lives on and strives toward the future. They have almost doubled their income, and are striving to for the next big thing. For example, Facebook is looking into making its own revenue by releasing its new mobile phone with Facebook at the center. The worth of the company and its stock will almost surely continue to increase. In any event, the stock was simply overhyped, overpriced, and the logistical errors caused the dramatic drop in initial value. This was not a Facebook IPO failure because the factors for the stocks decline rested on outside factors. It was a technical failure and an investment bank failure that led to an investor failure.Even if some believed that the initial public offering of stocks was not so successful there is no reason to doubt that Facebook is becoming one of the more successful stocks on the market today.

Works Cited www.facebook.com finance.yahoo.com

Swanberg 10 Vejacka, Martin. "Facebook Advertising and its Efficiency on the Slovak Market." E+M Ekonomie a Management.1 (2012): 116-27. ProQuest. Web. 11 Mar. 2013. Dharmarain, Sheila. "Facebook's IPO Flop Is Decade's Worst." Bloomberg Businessweek22 May 2012: 6369. Web. Dr. Garry Bruton, Dr. Dev. Strategy and IPO Market Selection. Journal of Small Business Management. v35, n4, 1997. P. 1-10 Robertson, Jeff. "Empower Network." Empower Network. Emporwernetwork, 20 Aug. 2012. Web. 08 Apr. 2013. Winkler, Rolfe. "Playing New Zynga Game at Facebook." Wall Street Journal: B.16. Feb 04 2012. ProQuest. Web. 8 Apr. 2013 Raice, Shayndi. "The Facebook IPO: Facebook and Zynga: Sharing Riches Isn't always Easy." Wall Street Journal: B.7. Feb 03 2012. ProQuest. Web. 8 Apr. 2013 . International Business, Times. "Biggest Tech Flops Of 2012: Top 5 Failures, From The Facebook IPO To Microsoft Surface." International Business Times 28 Dec. 2012: Regional Business News. Web. 8 Apr. 2013. Platt, Gordon. "Waiting for Facebook, IPO Market Revives." Global Finance 26.3 (2012): 70-. ProQuest. Web. 11 Mar. 2013. writer, David Wigan. "Report: Equity Capital Markets - Facebook - Facebook IPO shows High Price of Failure." The Banker (2012): n/a. ProQuest. Web. 11 Mar. 2013. van der Goot, Tjalling, Noud van Giersbergen, and Michiel Botman. "What Determines The Survival Of Internet Ipos?." Applied Economics 41.4-6 (2009): 547-561. EconLit. Web. 7 Apr. 2013. Cusumano, Michael A. "Technology Strategy And Management: Reflecting On The Facebook IPO." Communications Of The ACM 55.10 (2012): 20-23. Academic Search Premier. Web. 11 Mar. 2013.

Swanberg 11