What Were iBanker’s Ethical Obligations to Facebook?

John Hempton at Bronte Capital often makes for an interesting read. Today, however, I have to disagree with his take on the ethical obligations of investment bankers in the Facebook IPO. (Facebook and the sad case of ethical investment bankers).

John writes:

“In an IPO an investment bank takes a fee from a business to place that stock in financial markets. Or, more precisely, they take a fee from a business to sell part of that business. Their customer is the company doing an IPO and they have a legal and moral obligation to get the highest price for the company they are selling. No more. No less . . .

The investment bank owes a duty to the seller of the IPO and that is all.”

I believe that statement is quite an oversimplification.

Perhaps it is the corporate attorney in me, but good counsel offered to firms going public needs to be more nuanced than “maximize price – period.” After all, IPO pricing is as much art as science; merely generating the highest IPO proceeds at the expense of every other factor is likely to be short-sighted.

Said another way, it may not be in the best interest of the company to say the hell with everything else, lets top tick our price at the IPO. (I will ignore the selective disclosure issues in order to stay focused on the IPO pricing issue in this exercise).

If I were Facebook’s iBanker, my ethical obligations would have included having a sit down with the company’s senior management team prior to going public, and offering up the following counsel, emphasizing these 3 points in particular:

“Folks, you have built a tremendous internet company in a very short time. Your brand recognition and reach are enormous, and the public perceives you as a (mostly) positive force in their lives.

However, there are a few issues that need to be resolved — some hair on the deal. Rather than detail all of them, let’s discuss three.

1. Pre Public: Let’s begin with the issue of all the publicly traded shares pre-IPO. You have practically gone public already given the extensive number of non-employee, non-venture backing shareholders you have; note that these public sales occurred without the usual legal disclosures, accounting statements or risk statements. These markets are opaque in terms fees and costs, lack full transparency as top pricing. This is why what they do cannot safely be called “price discovery.”

Thus, you have a growing class of shareholders who are uninformed about youre company and its prospects.

2. Valuation: The second issue stems directly from all those private and seemingly uninformed buyers — and that is the valuation. By any conceivable measure, the prices at which shares were changing hands in the private market were extremely rich. With revenues at $4B, and profits at $1B, pre-IPO, you are trading at 28X sales and 100X earnings. Just as a comparison, firms like Microsoft, Apple and Google all went public at 4-5X sales and 25X earnings.

3. Long Term Relationship with Your Investors: The buyers of your stock are looking to grow with the company over the next 5, 10, or even 20 years. The dual class structure is a red flag to many of the potential investors, and your pricing is the other. If you do not want a relationship with the mutual funds, indexes, and individual investors who are the potential long term holders of your stock, then why are you going public?

Even after this liquidity event, you are still very substantial owners of stock in Facebook. Have the patience to grow into your valuation, rather than trying to ring the bell at your IPO . . .

That is the advice I would have given.  Alas, we don’t know if such counsel was ever shared with the management team, but we do know that it (or anything like it) was not taken.

Here we are, several weeks post-IPO, and the stock is down 26%, trading for under $28.

Not only has the debacle dissuaded all sorts of investors from holding this issue, it may have even damaged Facebook’s brand. We probably won’t know the complete impact of the botched IPO’s total fallout until year’s end.

Meanwhile, Facebook’s stock continues to grope for a floor. My best estimate of fair value is when its in the teens — just like most of its users average age . . .

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