Facebook IPO: a lesson in the art of saying 'no'


Abigail Hofman
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As Facebook fights back – at least in terms of stalling its sagging share price – controversy continues to rage as to who is to blame for the inept IPO. On June 15, a month after the IPO date, Facebook shares languished 20% below their offering price of $38. Many are fingering the stock exchange, Nasdaq, as culprit in chief. For all that Nasdaq chief Bob Greifeld has come out since with his own mea culpa, saying he and his colleagues "owe the industry an apology", I am not so sure.

Sure, the fact that trading started half an hour late and that orders could not be confirmed for another two hours was problematic.

But was this enough to poison the whole offering? After all, the deal closed at the end of the first day around the $38 issue price. Facebook shares then plummeted over the next few days as investors started to question the ridiculously high valuation – 75 times estimated 2012 earnings – and the ability of the company to grow revenues from its vast user base.

Often, when a deal has a shaky start, it fails to flourish in the next few weeks. But surely Morgan Stanley, as lead underwriter, has to shoulder some of the blame? What the market is telling us is that the price for the deal was wrong. And who was responsible for pricing the deal? As a former capital markets banker, I can tell you the answer. It would have been Morgan Stanley together with the client. And Morgan Stanley would have made sure that it had the support of the other lead bookrunners, JPMorgan and Goldman Sachs, for its pricing decision.

In the case of Facebook, as the roadshow drew to a close, the decision-makers chose to increase the size of the deal by 25% and increase the indicated price range. The offering was then priced at the top of the indicated range. This was crazy. I am puzzled that a leading securities firm could have been taken in by the hype surrounding the deal. Against a backdrop of floundering equity markets, was demand really solid or was the book packed with orders from short-term flippers?

"You don’t understand, Abigail," a commentator grumbled. "If anyone’s to blame, it’s the Facebook executives. They got what they wanted: the highest possible price for their shares. They imposed the pricing and strategy on the banks."

I disagree. The role of a good client investment banker is to win for his firm. A lot of twaddle is mouthed about putting clients first. But investment bankers are handsomely paid to deliver for the bank, and that means protecting your firm’s profitability and saying "no" to your client. You can only say "no" to your client if the client trusts you, and that trust can take years to build. How such trust is built is another matter that I will return to.

Facebook managers may have been arrogant and stubborn: after all they have built an incredibly successful business in a short time. But the Morgan Stanley bankers had expertise and experience on their side. They could say: "Look, we’ve done 300 IPOs in the past five years, this will be Facebook’s first and last IPO. Please do it our way. Please trust us."

The Morgan Stanley banker then had to describe how vicious the press coverage would be if the deal didn’t go well. And he had to force the client to focus on the potential downside, not the intrinsic wonderfulness of the Facebook model.

Ironically, in future all a banker will need to say to a client at the pricing meeting is: "Please listen to me and my colleagues. You don’t want to have a Facebook experience!" It is the banker’s job to use his intelligence and diplomacy to shepherd the client to the right result. And the right result is the one that works for investors, underwriters and ultimately for the client: that they have a seamlessly executed transaction.

There is one experience from my career as a capital markets banker that always remains with me. I was working for Deutsche Bank and we were joint lead managers with Goldman Sachs on a bond deal for a supranational client. For the pricing call, I went with my syndicate manager to Goldman’s office and, together with one of Goldman’s top client bankers and their London-based syndicate manager, we spoke to the client, based in Washington, on a speaker phone.

The client of course wanted the best price. The Goldman banker and myself did most of the talking. We argued that the deal should be priced more cheaply to "leave something on the table" for investors and provide a favourable aura for secondary-market trading. It was a hard-fought battle. The client had a pristine credit.

They wanted every basis point they could get so as to disburse more to the deserving poor. The Goldman banker and I prevailed. The client grumbled but agreed to follow our advice. When the client gave in, I saw the Goldman banker shoot his syndicate manager a look of pure triumph. And it is that look that I have never forgotten. It shrieked: ‘I have delivered. I have persuaded my client to do what he didn’t want to do. I have protected our firm.’ This incident reinforced my belief that top bankers work for their firms not their clients and, if necessary, it is your job to say "no" to your client.

As for Facebook, there are a few important milestones looming in the next few months that will influence trading of the stock. Second-quarter results will be released in early July. Around that time the analysts employed by the firms involved in the issue will be able to produce research on the company. And then 90 days after the IPO date, certain insiders’ lock-up agreements expire and they can sell some of the stock they own. I will be watching to see if the worst is behind Facebook and the shares have put in a medium-term bottom.