Group Project – Investment Banking

Facebook IPO Case Study

Team : Lakshmi, Sachin, Bhupendra PGDM-PT (17’20)

 Agenda
 Company Description
 Controlling Shareholders Vs. Impact on IPO
 Timing of the issue – State of Economy, Industry, Recent
IPOs
 Flaws / Limitations in Valuation Techniques
 Conflict of Interest of various players
 Determination of floor price, price band
 Strategy and approach to Market Making
 Post listing outcome – Analysis & Reason
 Lock-up / categories of capital / Green Shoe option -
impact
 Company Description
• Facebook was launched in 2004 by Harvard student Mark
Zuckerberg, as an online version of the Harvard Facebook.
• Facebook lets users share information, post photos and videos,
play games, and otherwise connect with one another through
online profiles.
• Facebook has about 850 million total users and about 480
million daily users.
• The company had 3,200 full-time employees as of December
31, 2011.
• The company crossed the line into profitability in 2009, five
years after it launched by founder Mark Zuckerberg’s in
Harvard dorm room. Facebook earned $229 million that year
on sales of $777 million, and has remained profitable ever
since.
 Controlling Shareholders Vs. Impact on IPO
• There are two Categories of Capital / common stock – Class
A & Class B. The rights of the holders of the Class A and
Class B common stocks are identical, except the voting and
conversion rights. Each share of Class A carries one voting
right and Class B carries ten voting rights and Class B stocks
at any time is convertible into 1 share of Class A .
• Controlling Shareholder - Holders of Class B common stock
will hold apprx. 95.9% of voting power. Insiders hold Class B
common stock. Mark Zuckerberg, will hold or have the
ability to control appx 55.8% of the voting power of FB’s
outstanding capital.
• With this, Investors will have only 4% control and 96% of
voting power will be with Class B shareholders and
Zuckerberg would directly and indirectly control 56% votes.
 Controlling Shareholders Vs. Impact on IPO
Impact on IPO
• Facebook held its initial public offering on May 18 2012. This
was seen as one of the biggest IPO’s in technology & internet
history with peak market capitalization of over $ 104 billion.

• On May 16, two days before the IPO, Facebook announced

that it would sell 25% more shares than their originally
planned numbers due to high demand. This meant the stock
would debut with 421 Mln shares. Usually, retail investors are
allocated upto 20% of the total shares in an IPO.

• Being marked with an initial price range of high $20’s to mid

$30/share the price talk for FB IPO was increased to $34 to
$38, thus valuing the eight year old company at over $100
billion. The price made the IPO the largest in that year and
second largest in the US history.
 Timing of the Issue
State of Economy & Industry
• Global economy was still recovering from 2007-09 financial
crisis
• US economy was recovering from GDP forecasts
• US unemployment remained high at 8%
• Presidential elections in US threatened to derail the recovery
• Fiscal cliff issues were high
• Europe falling back into a recession, while the powerhouse
emerging market economies of China, Brazil and India
showed signs of faltering
• The market volatility and continuing economic uncertainty
had left the global IPO markets in the doldrums
Recent IPOs in Year 2011
 Flaws / Limitations in Valuation Techniques
• Facebook generates 80% of money through Advertising
• Facebook had sets its price band at $28 - $35 per share. But
just before the IPO is launched the company raised the price to
$38 per share
• After the negative disclosures and insider trading, it became
very clear that the facebook shares were not perfectly priced
• Inspite of the shares being over valued, Facebook had
increased the number of shares by 25%
• When the quick profit failed to materialize, a couple of days
after IPO, the investors who received more shares became
forced sellers
• Facebook leaders and their IB company were pushing for sale
of shares at the top end of their price range
 Conflict of Interest of various players
Firm, Underwriters, and Investors are the main three players in an IPO
and all of them had their own potential conflict of interest in an IPO.

Firm (Facebook)
• Would want a successful IPO
• Would like to raise as much capital as possible
• Wants the share price to rise immediately after the IPO and setting
up stage for future secondary offerings
 Conflict of Interest of various players
Underwriters,
• Underwriter sought to build relationship with companies in the
hopes of advising them on additional capital raising or potential
mergers and acquisitions.
• The Underwriter allocates and prices shares in sucha a way that it
makes more profits from the commission by setting a high price.
Here, Underwirter’s interest coincides with that of the issuer. In
contrast, when a spread is small, the underwriter sets a low price to
make gains from the underpricing and post IPO reselling of shares in
accordance with investors interests

Investors
• Investors were anxious to buy shares in hot IPOs where the shares
were expected to ‘pop’ on the first day by up to 35%.
 Determination of Floor Price, Price Band
• The U/w earned their fees by selling stock to investors.
Investors were anxious to buy shares in hot IPOs where the
shares were expected to pop on the first day by up to 35%. In
case, the issue did not ‘pop’, U/ws were expected to offer price
support, which meant maintaining a floor price which is
minimum price, at which bids can be made for an IPO.

• Price Band usually contains an upper level and a lower level

Price for the IPO. Facebook had sets its price band between
$28 - $35 per share
 Strategy and approach to Market Making
With market making strategy the marketers improve the liquidity for
company’s common stock. The result is better pricing of shares better
liquidity in the stocks help investors to sell their holding easily at any
point with their convenience. It also encourage new investors to buy the
stocks as market making offerings assure liquidity.

A market maker is responsible for continuously quoting prices at which

they are willing to buy and sell for stocks. They are paid for the risks of
holding the stock i.e the decrease in the value of security after it has been
purchase from a seller and before it is sold to a buyer.

In early May, FB was aiming for a valuation somewhere from $ 28 -

$35/share ($77 billion - $96 billion). On May 14th , it raised the target to
$34 - $38/share .

Strong demand specially from retail investors suggested that FB could

choose a relatively high offering price and ultimately the underwriters
settled on a price of $38 . The price valued the company at $104 billion.
 Strategy and approach to Market Making
The Top market makers in the FB IPO were Knight Capital , Citadel
Securities, USB AG and Citi’s Automated Trading Desk

Due to technical glitches on the debut of FB IPO, there was chaos

and confusion. The brokers who quote bid and offer prices
struggled to figure out what was happening.

Even investors were in dark as to whether their trades had gone

through or not in some cases even after many days.

The turmoil caused four big market makers mentioned above to

loose around $115 million between them.

For market makers the chaos was particularly problematic,

because they did not know what they and their clients owned and
at what price.
 Post listing outcome – Analysis & Reason
• FB share price rose during the first weeks of June’12 to well
over $30, but it then began to fall again, reaching a new low of
around $23 at the end of July’12 shortly after the company's
2012 second quarter results revealed losses of $157 million for
the period.
• However, these losses were mostly due to expenses related to
the IPO, and it's still very early days for Facebook's career as a
public company.
• Some analysts believe that turbulence in Facebook's share
price may simply represent the teething troubles that are
standard for many new public offerings, rather than the
beginnings of a terminal fall from grace. Also, for most public
companies, "the biggest period of volatility is immediately
after a float - it takes some time for the share price to find its
natural level".
 Post listing outcome – Analysis & Reason
The FB IPO had immediate impacts on the stock market. The overall impact
can be covered under the following

Financial impact: Investment firms faced considerable losses due to

technical glitches. Bloomberg estimated that retail investors may have lost
approx $630 million. Key market maker USB AG may have lost $ 350
million. NASDAQ stock exchange offered $40 million to investment firms as
against the provision of $3 million.

Shareholding : As per Exhibit-8 the shareholding pattern underwent a

change. Mark Zukerberg would be able to sell 3.02 million class B shares
and would encash almost 1.05 billion in cash. His remaining 504 million
shares will make him worth $ 17.6 billion, if FB hits the top of its IPO range.
Mr. James Breyer of venture capital firm Acel Partners is offering 38.2
million shares and would pocket $1.33 billion. Goldman Sachs would
unload 20% of its stake and take home $ 462 million.
 Post listing outcome – Analysis & Reason
Legal Impact : More than 40 lawsuits were filed regarding the FB IPO in the month
that followed . The underwriters as well as FB CEO and board also faced litigation.
It was alleged that adjustment to earnings estimates were communicated to the
underwriters by a FB financial officer, who used information to cash out on their
positions while leaving the general public with overpriced shares. Morgan Stanley
settled allegations of improperly influencing research analysis for $5 million in
December 2012

Regulatory: FB’s IPO was under investigation and it was compared to various
Pump and dump schemes . Govt officials called for investigation in following
weeks. Regulators from Wall Street’s Financial Industry Regulatory Authority
announced on may 22nd 2012 that they had begun investigating whether
underwriters of FB had improperly shared information only with select clients
rather than general public .

Reputational : The reputation of both Morgan Stanley the primary IPO

underwriter and NASDAQ were severely damaged in the fallout of offering. By
signing off an offering price that was too high or attempting to sell too many
shares to the market
 Lock-up / Categories of Capital / Green Shoe
Option impact
• There were Five Lock-up periods specifying when insiders
could sell additional Shares, 91 to 366 days after the IPO.
These Lock-ups affected a total of 1872 Bln shares out of the
2138 Bln that would be outstanding post IPO.

• There are two Categories of Capital / common stock – Class A

& Class B. The rights of the holders of the Class A common
stock and class B are identical except the voting and
conversion rights. Each share of Class A carries 1 voting right
and Class B carries 10 voting rights and at any time is
convertible into 1 share of class A . Holders of Class B
common stock will hold apprx. 95.9% of voting power .
Insiders hold Class B common stock
 Lock-up / Categories of Capital / Green Shoe
Option impact

• The underwriters had an Green Shoe Option (over allotment)

that allowed them to sell up to an additional 15% of the
offering. The U/w could sell a total of 484 Mln shares even
though they only had an allotment of 421 Mln shares, i.e. U/w
could effectively short 63 Mln shares. Successful IPO and if the
share price rose beyond issue price, the U/w would exercise
green shoe option with FB to cover their short position. With
unsuccessful IPO and share price go below the issue price the
U/w would buy shares in the market to cover their short
position. The U/w would earn1.1% on any share in the IPO