Congratulations Facebook Underwriters

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FacebooknaileditCongratulations to Facebook’s underwriters, you got it exactly right.  There should be no disappointment.

To explain, a quick overview on IPOs.  A company goes public to acquire cash that it needs to grow.  It is the job of the underwriters to estimate the price that public investors are willing to pay for a share of stock on the day of the IPO.  This number is very important to the company because the money that the company gets is based on this price.

For example, if the underwriters price an IPO at $10 and the stock jumps to $50 on the first day of trading, the company still only gets $10.  The difference between the IPO price and the closing price $50 – $10 = $40 goes to the investors who bought at $10 early in the day and sold at $50 at the end of the day.  In this case the underwriters failed.  The company could have received $50 but they only got $10.

Facebook’s IPO was priced at $38 and trading finished the day at $38 and change.  The underwriter’s estimate was near perfect.

So why are their so many articles saying the IPO fizzled, disappointed, and failed to live up to the hype?  Well the example I described was based on economic theory, not reality.  There are a couple reasons why the price normally jumps significantly during the first day.  First, the banks (who employ the underwriters) have a vested interest in a stock price that skyrockets on the first day of trading.  This is because the banks most valued customers are among the few who can buy at the IPO price.  If the price skyrockets, these valuable customers are really happy.

Second, the company’s executives, who hire the bank, normally hold a lot of stock.  Their net worth is based on the closing price, not on the IPO price.  So the bank’s best customers are really happy if the underwriter’s estimate is too low (as in my example) and the company’s executives are mostly indifferent.  Getting it exactly right has no upside.  No one congratulates the underwriters.  I think they should be recognized for a job well done.  So congratulations Facebook underwriters, you nailed it!

Image credit: www.FreeDigitalPhotos.net

How do you Measure the Universe? Trying to Understand Facebook’s Valuation

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I’ve been trying to comprehend Facebook’s valuation this weekend.  $100 billion is a huge number.  But just how huge?  To try to put this in perspective I looked up the most valuable companies in the world.  There are only about 50 companies in the world worth $100 billion or more.  This group includes the world’s largest banks, energy companies, and pharmaceutical firms.  It includes unique firms like Microsoft, the company that sells the operating system that runs most of the world’s computers and the productivity software used by most of the world’s knowledge workers.  It includes Apple, the innovator that changed the music business, the mobile phone business, and created the market for tablets.  This group also includes the enduring brand and entertainment giant Disney.  And it includes fellow Silicon Valley resident Google, the company that helps most of the world find things on the internet.  Quite an exclusive club.

Facebook is the world’s largest social network.  More than 10% of the world’s population has a Facebook page.  Facebook’s users include most of the people in the world that advertisers care about.  These measures make a good argument for putting Facebook in this club.  But now that Facebook is in this club, less than six years after the public launch of their product, what now?

Google is trading at around 7x it’s 2004 IPO price.  Microsoft is trading at 200x IPO and Apple 100x IPO.  And yes, those numbers are adjusted for inflation.  To become the most valuable company in the world, a title currently held by Apple at around $500 billion, Facebook needs only a 5x increase.  Based on these numbers, Facebook could become the most valuable company on the planet in the very near future.

So how huge is Facebook’s valuation?  World domination huge.