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Facebook IPO underscores shutting out the masses

Skewed payoff: Early investors win big; individuals lose

By , Chronicle Columnist
A potential investor carries a Facebook prospectus as he leaves the Crowne Plaza Hotel in Palo Alto on Friday, May 11, 2012 in Palo Alto, Calif.
A potential investor carries a Facebook prospectus as he leaves the Crowne Plaza Hotel in Palo Alto on Friday, May 11, 2012 in Palo Alto, Calif.Lea Suzuki/The Chronicle

The Facebook flop is just the latest evidence of a growing and unsustainable imbalance across the tech investment spectrum.

On Monday, Facebook's shares dropped through the initial public offering price of $38, falling nearly 11 percent to close at $34.03. That follows a string of tech firms that have seen their stock dip below the offering price in recent months, including Groupon, Zynga and Angie's List. Others like Yelp and Zillow are above their offering price, but below where the stock started trading on the first day.

It means that venture capitalists and angel investors are consistently winning big, leaving little money on the table as they liquidate their holdings. But the pension funds and other institutional investors that buy up the shares at the offering price - and the individual investors who can only snag shares once trading starts - are getting hosed.

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The real money has always flowed backward to the early investors - rightly so, since they're taking the big risk on unproven companies. But when it's time to go public, investors and businesses are increasingly doing everything they can to cling to every last penny.

Underwater at the bell

The Wall Street Journal pointed out that Greylock Partners' $12 million investment in Facebook in 2006 is now worth about $1.15 billion. Meanwhile, anyone who clicked "buy" in their Schwab account on Friday morning was underwater by the ring of the opening bell Monday.

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"Facebook left nothing for the common investor," Forbes Publisher Rich Karlgaard wrote. "The insider pig pile of (private equity) firms and celebrity Silicon Valley angels took it all. This is a rather new, post-Sarbanes-Oxley fact, and it should make Americans very, very angry."

There are real consequences to this for the sector, individual companies and perhaps the IPO process generally.

Underwriters like Morgan Stanley or Goldman Sachs can only hawk tumbling stocks to their institutional clients so many times before those clients stop doing business with them and cool to the industry overall. That makes it harder for the next social-media company that wants to go public.

Busted IPOs' impact

In addition, a "busted IPO" that falls below the offering price has a real impact on investor sentiment. The flop dampens enthusiasm for the shares, potentially leaving less money for the company to tap for future growth and acquisitions.

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Had the Menlo Park social-networking giant priced at $30 and shares rose to $34, business journalists would be writing very different stories and the momentum would be moving in a different direction. Venture capitalists wouldn't have cleaned house, but Facebook employees holding stock options would have better odds of selling for a gain when their lockup period ends months from now, said Trip Chowdhry, an analyst at Global Equities Research.

"VCs made tons of money," he said. "Facebook employees got screwed."

To be sure, Facebook is already a clear business success. The company said its revenue last year totaled $3.7 billion as profits reached $1 billion.

"But they priced (the IPO) completely wrong - and a failed IPO gives a bad impression of Facebook," Chowdhry said. "A key message here is that hype doesn't sell anymore, short of fundamentals."

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Smart money dubious

The problem is that the smart money on Wall Street simply doesn't think the company's prospects justify the $105 billion that the offering price implied.

And no wonder. That values the company at 108 times 2011 earnings, requiring almost ridiculous financial growth to make sense. By way of comparison, Google trades at less than 19 times earnings.

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Yet Facebook warned in its Securities and Exchange Commission filing that its revenue and user gains are slowing, trends likely to continue. After all, the downside to a user base approaching one-seventh of the world's population is that the easy customer wins are over. The untapped opportunities are in China, Africa and other areas that present serious technical and geopolitical obstacles.

Unproven model

Facebook may try to wring more revenue from the users it has through more or better advertising, in a bid to meet what will be insatiable investor demand for growth. But the company's users are sensitive to invasive marketing and major advertisers have already raised questions about the effectiveness of ads on the site.

"Although Facebook is very promising, it's an unproven ad model," said Brian Wieser, analyst at Pivotal Research Group, who has a $30 price target for the stock. "The revenue growth is not assured. There are a lot of risks that were not really reflected in the pricing at the IPO."

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James Temple is a San Francisco Chronicle columnist. Dot.commentary runs three times each week. E-mail: jtemple@sfchronicle.com Twitter: @jtemple

James Temple writes the Dot-Commentary column for The San Francisco Chronicle and SFGate.com, focusing on technology policy issues, innovation and major trends in the industry.

Previously, he covered the Internet beat, focusing on Google, Yahoo, eBay and Microsoft. James has been a Bay Area business reporter for more than a decade, covering advertising, banking, retail and real estate for the San Francisco Business Times, Contra Costa Times and Bloomberg.

He has won a number of awards from the California Newspaper Publishers Association, the National Association of Real Estate Editors and other groups. James also does video production for SFGate.

He is a graduate of Ohio University's E.W. Scripps School of Journalism.