Facebook's IPO misfortunes share many fathers. Wednesday's news that the company, its underwriters, and its CEO have been sued by its own investors less than a week after going public is just the latest in a litany of bad news. In Massachusetts, state investigators have subpoenaed lead underwriter Morgan Stanley, asking the bank to disclose any information about its communications with institutional investors; SEC Chairman Mary Schapiro has promised an investigation by her agency, as has FIRA, Wall Street's own regulating body; and NASDAQ admits that its technical problems botched the key first few hours of trading the newly issued public stock. More than four percent of Facebook's public share are reportedly being held on loan by traders looking to short the stock, betting the share price will continue to fall. A source even told Reuters that Facebook was considering moving its stock listing from NASDAQ to the New York Stock Exchange, like a quick do-over. (The NYSE quickly denied any talks with Facebook.) Taken together, you might conclude that the whole event is a catastrophe, if not an outright scam, perpetrated by the powerful at the expense of the powerless.
Still, we should take a moment to take stock of the investigation so far. It's not at all clear that Facebook has done anything wrong, or that the company's executives could have done otherwise than what they did.
Mobile Facebook use is going up; that means Facebook revenue is going down
Here's what we know. On May 9th, Facebook revised its S-1 disclosure to potential investors, noting that its users' shift to mobile devices and its inability to generate real revenue from those mobile visits was going to be a factor in its second quarter balance sheets. This was after the company had already reported a revenue dip for the first quarter. Here is the key section of the May 9th S-1:
We do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven. We believe this increased usage of Facebook on mobile devices has contributed to the recent trend of our daily active users (DAUs) increasing more rapidly than the increase in the number of ads delivered. If users increasingly access Facebook mobile products as a substitute for access through personal computers, and if we are unable to successfully implement monetization strategies for our mobile users, or if we incur excessive expenses in this effort, our financial performance and ability to grow revenue would be negatively affected.
According to reports by Reuters and other sources, after issuing the revised S-1, Facebook told the IPO's underwriters to lower their revenue and profit estimates for the current quarter. The banks' analysts did — Reuters reports the revised numbers here. (The banks' targets are quite close to each other, although they were before the revisions, too.)
Every potential investor had access to Facebook's S-1, with the warning about mobile revenue.
But not every potential or actual investor had access to the banks' specific projections. Some key clients of those banks apparently did, and revised their purchases of Facebook stock accordingly.In itself, there's nothing wrong with any of that, particularly for Facebook. (For the banks, it's a little murkier, because the side of the bank that underwrites and IPO and the side that analyzes it for investors are supposed to keep some distance from each other.)
According to accounting watchdog Francine McKenna, revenue projections aren't governed by GAAP or disclosure rules like proper quarterly revenue statements. This is true for public companies and especially for companies who are only about to go public.
To truly implicate Facebook, this would be the big argument you would have to make:
- Facebook should have withheld its revenue projections from the underwriters pricing its IPO;
- Facebook's warning about mobile revenues was arcane and misleading to rank-and-file investors.
These arguments are already starting to be made. For instance, this is what Business Insider's Henry Blodget wrote on Tuesday:
The appearance of this language [in the May 9th amended S-1] unnerved some sophisticated investors and analysts, who took it as a sign that Facebook's business might have deteriorated. The language was vague, however, and — to this former analyst, at least — it did not convey that Facebook's second quarter was weaker than expected.
That's surprising, because on May 10th, Business Insider ran a post titled "Facebook's Amended S-1 Is Worrisome — Its Mobile Growth Could Be Hurting Revenue Growth." On the same day, Blodget himself wrote (in a post titled "Facebook is 'Muppet Bait'") that it was clear that casual investors should stay away from buying stock in Facebook, in part because "Facebook is unlikely to be able to generate as much revenue per user from mobile as it does from the web, and the world really is going mobile. (Facebook actually just cited this in its latest IPO filing amendment)." The same day, Blodget also went on CNBC and said the same thing.
In fact, the conventional wisdom after Facebook's revised S-1 was that this was very bad news indeed for upcoming revenue. Some suggested (as Yahoo News' Matt Nesto and Jeff Macke presciently argue here) the revision's express purpose was to discharge the company's legal responsibilities. It's more "about lawyering and pre-arguing class action lawsuits from shareholders that might come in the future; Sort of a pre-10Q, if you will." A 10Q — i.e., the company's financial statement from its first public quarter.
It's possible that there were much deeper shenanigans here, active deception by Facebook and its partners that don't just somehow seem unfair, but actually ran afoul of the law. After all, a class-action lawsuit against Apple and book publishers over fixing e-book prices seemed like a reach a few months ago, before all the facts came to light.Still, we have to avoid rushing to judgment or lapsing into selective amnesia, however tempting it might be.
The real problem is that everything that was already problematic about Facebook's IPO has wound itself into a single gigantic knot. There were failures of execution, from NASDAQ's inability to process trades to the relatively late decision to make many additional shares available for trading. The first artificially helped create too much demand, the second too little. If the stock's launch had gone off without a hitch, and the price had immediately popped or rose steadily, most of the complaints about procedure would evaporate.
There are also serious questions about Facebook's fundamentals
Can it really continue to grow using strategies from a desktop age in an increasingly mobile world? Are its accounting practices on the level? Does Zuckerberg still have too much control and too little accountability? Does advertising on Facebook even actually work?
There are also longstanding problems of too little transparency and too much privilege in our financial system that remain unaddressed. Many of us projecting our causes and anxieties onto this event, or using it as an excuse to let them loose.
It's easier to look for bogeymen than to face up to problems without easy solutions and questions without easy answers. Without a smoking gun, this becomes just another sideshow to a sideshow — a bubble of false dread to replace our false hopes, now lost.
Ben Popper contributed ideas and reporting to this story.