The Facebook Financial Fiasco

a mellow Friday. I guess let's take it down to not actually one of the thing that we're going to talk about today could be a little slow and you know, in places for some people. But I think we're going to try to make some sense out of it. Yeah, that's try is the operative word here, all right. So we already talked about Facebook and the fact that it was going to hold an I p O and initial

public offering. Basically they're going to in the past when we were talking about this, they're going to put out stock so that people can buy shares in the company. And they were actually to some degree forced to do, so they reached a certain size for a certain length of time, and basically there was a responsibility that they had to take themselves public, going from private company to public company. And then uh, in May they made their

initial public offering and billions of dollars. Yeah, it's actually we should probably talk a little bit about that. Excuse me. So the I p O goes out and on May sev Facebook ends up raising about sixteen billion dollars in in uh the first day there. That's that's how much they made in their I p O. But the interesting

there are several interesting things about this. One is that the opening price for a share of Facebook stock was thirty eight dollars, right, but which actually, from why understand, been adjusted down slightly from what it was originally going to be. Yeah, And and what happens is, um, don't ask me to explain the stock market to you, um, But in general, what happens is they set sort of a range of prices what they expect to launch at.

And it has to do in part with the the valuation of the company, what investors think the company is worth, and also what you know, how the company has been performing recently. So that and that's going to play a

really big role in our discussion here. Yeah, I thought it was worth about fifteen cents, but they shouted me down on that, right, So they said thirty eight dollars per share, which, by the number of shares that were out going to be available on this initial public offering, would have put the value of Facebook and about one

hundred and four billion dollars. So yeah, if you if you sell it for scrap, that's what they felt like it was going to be working, right essentially, So that's I mean, that's a huge, huge amount of money and in fact was going to make Facebook, in fact did make Facebook the biggest tech I p O in history, not the biggest I PO in history, but the biggest

one for a tech company for now. For now. Yeah, the records were made to be broken, right, but the entire thing has kind of spiraled into this semi scandalous

uh story. Yea, and scandal depending upon your own perspective, because it may very well be that even if things that you might think unethical happened, if even if the actions you think are unethical, even if those did happen, it may very well be that those unethical actions are not in themselves illegal us as a caveat for our the conversation that has taken place so far and and is to come. Um. As of the date we're recording this in May, Facebook stock has been out on the

market for approximately one week. It was actually we record on Friday, so it was done the thursday before. Uh so it's been one week in a day. So um. A lot of this material that we that that we will be talking about is stuff that came out this week. UM, So we record in advance, so they're they're probably if you're going what everybody knows about this, you know and how far it goes, Well, it's gonna bee that came out after we recorded this, so we wanted to talk

about it because it's it's weird. We're recording it specifically on MA and UM on. The closing price of Facebook stock on May was thirty two point o six, so it dropped from thirty eight to thirty two, and some analysts think that that's not going to be that's not

gonna be the end of it. Then in fact, Facebook stock could fall as far down as twenty two dollars a share by November, which would be a dramatic would be a decrease in value, which in in investment terms is what we usually call a bad thing, assuming that you're actually buying stock in Facebook. We'll talk about some of the other elements here too. So here here's something. There were several things that were strange about the the

first day of trading for Facebook. Thing number one. So Facebook stock trades on in the US on NASDAC, the NASDAC Stock exchange for a couple of different stock exchanges, NASADA is one of them. Yeah, And then a stock exchange is basically a place where representatives by and sell shares of stock. So if you work through an investor, uh and put in in order, the investor will talk to the representatives on the trading floor and they put

in the order for you. Um, and the stock prices change in the blink of an eye so times less. So you know, you you say, hey, I want to buy um, let's say it it I p O is at thirty eight dollars And you say, well, I'm not going to hit it right away. I want I want to buy fifty shares of Facebook immediately, and then you'll you'll get it at whatever price it is. Then um, you might say oh, well, I want to when it

hits forty dollars or less. Then you know if it if it goes up to forty, you've missed your shot until it drops back down. So the the exchanges where they make trades and things like that happen, and just like that they make trades happen, we should we should also mention that in in and investing their multiple strategies. So you've got people who are like day traders, who are looking for the really short term turnaround, like they

like high volume, high volatility. That's what day traders thrive on because they're trying to make lots of money and as little time as possible, which is kind of like betting. Yeah, it's like gambling. So you're you're betting that a stock price is going to fall or going to rise in a certain amount of time, and you're trying to make money off of that. Then there's the long term investment where you're thinking, no, I'm buying shares in this because

I believe in this company. I believe that this company ultimately is going to uh to succeed over the next several years. And so this is a true investment in the company, and that I will get a return on that investment. Perhaps I'll actually get paid out returns on my on my investment dividends exactly instead of looking just

to buy and sell. So anyway, on that day, on May sevente what what was typically happens on a trading day is that the stock market, the Nasdaq Stock Exchange begins trading at nine thirty in the morning, however Eastern

Standard time Eastern Stanard time. However, for I p o s for initial public offerings, those trading UH shares usually don't pick up until an hour after the market opens at least, so you usually have about an hour or maybe a little bit longer of grace time between when the market opens and when an I p O actually begins its initial trading. So NASDAC had planned on the Facebook shares starting to go on trade on the floor

at around eleven o five in the morning. But eleven in the morning comes and goes, and no shares are being traded, and this already kind of got some potential investors a little worried, like what is going on? And then uh, they finally started to go started to trade at around eleven thirty in the morning. And the reason for the delay or one of the reasons for the delay.

First of all, Nasdac says the reason for the delay was a technical glitch, but one of the one of the and there were there were several things that fell out over that, and it's still as of the recruiting of this podcast, it's still unfolding. But one of the possible reasons for the delay is that a lot of significant number of shares, or rather a significant number of shares switched what was going to happen before trading started.

So in other words, before trading starts, you usually have sellers who who express an interest in selling a certain amount of stock and buyers who say they want to buy a certain amount of stock. And as that goes and tries to match up the buyers with the sellers so that its smoothly begins as soon as the trading opens. Because there are a certain number of shares of stock, it doesn't continually just make new shares. I mean there's there's you know, because there's a limit to the number.

You if you can't have more shares being bought then sold, h but you can't have more shares sold than But that's what turned out to be the case, what happened was a lot more of the initial investors in Facebook seemed to want to sell shares then had originally been UM been planned for. So so, in other words, a lot of companies, really banks things like that that had a significant interest in Facebook wanted to dump that stock faster than what NASDAK had planned for because something had

changed before trading began. Yeah, and it's important to note too that you may say, well, if they didn't trade until thirty, how did they get that? Well, UM, and the cases of of I p O s like this UM, people who are involved in the company, say co founder and CEO Mark Zuckerberg, people who are involved with the company have a certain amount of stock that they are granted as a you know, hey, you have a thousand

shares of stock for working for us. As soon as it starts trading, you will be given the option to you know, to have that stock, to own that stock right there reserved for you. So these investors already have a certain part of the company, and so they are granted an equivalent amount of you know, stock that as soon as the stock market starts trading, they can sell that if they want to. So they didn't have to go buy it and then sell it again, so just

if you were wondering where that came from. So they already had a share. Within the first thirty seconds of trading, eighty million shares changed hands. That's a lot. That's a lot of that's a lot of shares. And then, uh, there were several other problems that cropped up um after

this technical glitch thing. One of them was that some traders were reporting that they were getting delays when they were putting in orders, so they weren't really sure if the shares that they had had transferred over or if they were buying a share, they weren't really sure whether or not they possessed it at this point because they

were getting delays in the system. And on top of that, um there were other issues, uh, not just not just the delays, but that traders were saying that they were getting charged a higher price than what they had expected based upon when they made their purchase. These are both really bad things in general. Now, the real scandal surrounding the Facebook I p O doesn't really involve that. I mean, that's a problem, but that's a NASDAC problem, not necessarily

a Facebook problem. The scandal is about why these initial investors started to sell off shares or large companies that had the opportunity to buy up shares, why they did not rush into the market. And it's the difference between how a company like Facebook treats these major investors versus the average investor. So let's to to really explain this, it will be helpful to kind of make an analogy.

Let's say that Chris is a fat Cat banker who runs fat Cat Banking Limited, sitting here, I don't know, and then I am average Joe, the investor for Facebook. I just want I want to buy a share of Facebook. Well, what seems to have happened, and this is all alleged at this point, because as of the recording of this podcast, there has not been an investigation UH and there's only been sort of some vague accusations. So I want to say that what appears to have happened based upon the allegations.

What appears to have happened is that Facebook took a look at its UH last quarter results and they did not perform up to the expectations of the company, which means that Facebook was not making as much money as it had wanted to And this is something that affects the investor community because again, the value of a company and part is about how well it's doing in the marketplace. Right. The once you become public under well, you're you're governed

by the laws of wherever the stock exchanges. So under American law, UM, the Securities and Exchange Commission require uh that you, as a public company, file documents with them letting them know what's going on. And that information is public knowledge. So you have to say, look, I think we're gonna sell more stuff than we've ever sold before, or you know, last quarter half of our customers ditched us and went to another provider. You have to let them know that you have to divulge. So yeah, and

so this is the thing they had. You know, being private, you can keep all of that to yourself because you don't have to worry about the the investor. But um, in this case, the federal government was you know, requiring them to to make this information public. Um. And what happens in this case too is that they the big wigs in the company, are responsible for going out on

what they call a road show. So they have to go out and speak to investors and tell them about the health of the company, about what they expect going forward, about their performance in the past, and all sorts of little details Mark Zuckerberg had, But Mark Zuckerberg has a mole on his left, you know, temple, and that means that we're going to be more profitable. All sorts of little details. It's not those kind of things. But give it like a high rolling ad campaign. Yeah, this is

why you should invest in us. We we really think we're going to grow. This is what the forecast indicates. And but that information has to be made public under this law. So here's the thing. Apparently, according to the allegations, uh some person in the know in Facebook went to some of the largest banks that were part of handling

this whole I p O system. Uh so Morgan Stanley being chief among them, and went to went to these banks and said that the last quarters financial results were poorer than expected and that would in fact affect the value of the company somewhat, Which meant that these these large institutions had enough information to know, hey, maybe we shouldn't buy up a whole bunch of Facebook stock because

it could be overvalued. That thirty eight dollars per share may not really reflect the value of the company based upon these last quarter results. But Facebook did not divulge the information to the average investors. So, in other words, Chris gets a phone call and he gets a verbal message on that phone call that says, we didn't do as well as we thought we were going to do last quarter. Uh, that's probably going to affect the share price.

And I thought you should know, I do not get a phone call as as average investor, you know, average Joe, the the American investor. I don't get a phone call. So when the stock goes on the floor and it opens up for trading, I jump out and I buy it at thirty eight dollars a share. Meanwhile, the multibillion dollar bank industry does not jump in because they already has the foe knowledge, knowing that that price does not truly reflect the value of the company as it stands

based upon those last quarter results. The stock price for Facebook fell as low as down to thirty one dollars, and like I said at the beginning of this podcast, as of the recording of this it's currently at thirty two dollars and um in like six cents, which is significantly lower than thirty eight dollars per share, So people, the average investors were hurt by this. You know, they went out and they bought it at full price, thinking that that was a valid valuation or the company it

was approved, it was ready to go and everything's cool. Meanwhile, all these companies that were in the no adjusted their figures for what Facebook's results would be and what they're projected results would be in the future and did not jump into it. So that caused a lot of people to cry foul, saying this isn't fair. Facebook. Let these big companies know, these big banks mainly no financial institutions know that things were not quite as they seemed. But

they didn't let us know. And as a result, we've lost money. Uh, while we were trading in good faith. And uh, here's the thing. Facebook was allowed and I p O is allowed to give verbal information like that to major investors that there's nothing wrong with that as the law stands in the United States, and there's nothing that requires Facebook to make that aim statement in any

other format to anyone else besides those investors. So based on a strict legal definition on that approach, it's you know, Facebook quote unquote did nothing wrong. Now wrong in ethical like wrong in the eyes of the law and wrong

in the eyes of ethics are two different things. You know, a law does not have to necessarily be ethical just because it's just because it's not illegal, doesn't mean it's the right thing to do right right exactly, just like breaking certain laws may not break ethics, not that you should break the law. Obey the lawheads, so go to school. This has uh inspired several investors to get together and sue Facebook. As a result, there are more than one

lawsuit now class action lawsuits. So it's a law of The lawsuit was filed in the U. S. District Court

in Manhattan. Uh and UH, it's essentially saying that Facebook told analysts at its underwriters, which were those financial institutions, to materially lower their revenue forecasts for so that you know, that's the essentially saying the company is not going to make as much money in twelve as we originally thought we were going to, and that without letting that information go out to the public, it was running kind of a shell game and distracting us while letting us buy shares.

Us being the average Joe American um buy shares at full price. I want to correct something I said. UM, they're looking, they're hoping to make a class action. They haven't yet as far as the recording of the show. UM. And also at the same time, the Massachusetts Security Division has subpoena at Morgan Stanley about the communications with clients

about this UM these adjusted forecasts. So really the train of events is that, of course, if these allegations are true, If the allegations are true, what happened is Facebook executive goes and tells financial institutions, including Morgan Stanley, our forecasts for Facebook's revenues in are off. We're not gonna make them.

We're not gonna make that much money. Morgan Stanley then goes and tells major investors that are customers for Morgan Stanley, Hey, Facebook is not going to make its numbers this year. The price that we're being quoted is probably not indicative of its actual value. You may not want to invest. And meanwhile, everyone else on the street is trying to get that thirty eight dollars share of thinking that Facebook shares are going to go through the roof. Now that

sums up the big scandal. There's some other things that I think would be interesting to talk about that relate to Facebook going public and Facebook way Facebook generates revenue, and some of the challenges that the company faces. So let's say that the company whether's the storm and whether or not it means that they have to do a settlement of court or they win whatever. They get through this. So there's a particularly rocky I p O. But it was also a very large one, and there were other

mitigating factors that kind of confused it. So they get through that, where do they go from here? That's actually a really interesting question because Facebook, according to uh to an article I read, Facebook makes around of its revenue from web advertising, So the majority of money coming into Facebook comes in through web advertising. That's uh. That's both a good and a bad thing. It's good in the sense that Facebook has an enormous customer base or enormous

user base. I guess you could say, uh, nine million users. That's a lot of people, just under a billion people, probably gonna hit more than a billion before the end of Yeah, so you've got just under a billion people using your service. That's a lot of eyeballs to get to see these ads. However, the value of web advertising

as a whole is in decline. And particularly on Facebook, where Facebook has tons of information about user behavior on Facebook and not that many Facebook users are actually visiting the ads that are served up on their pages, which is another one of those indicators that people actually were saying in the days before, immediately before the initial public offering, that wouldn't matter that much. But in hindsight it kind

of was a a small flag. UH General Motors, the UH American automaker, had decided to pull its advertising from Facebook, saying it wasn't particularly effective. Um, that didn't really he seemed to dampen enthusiasm for the stock by itself, but it could have been an indicator that something is wrong. And you know, I mean they they are one of the biggest companies in the world, even after the what

some people are calling the Great Recession. Um, you know that that's if they don't believe that advertising on Facebook is going to be effective, then you know that that is a sign to investors said, hey, they may not

be able to make their money. Now they were only one very large company to have done that immediately preceding the I p O. But you know, it's it's one of those pieces that in again in hindsight, looking back on it, you might have said, you know that that was a little bit of an open yeah, and anything

might be wrong. The other element to this is that, uh, the way Facebook is currently trying to to, uh, to balance out the fact at web ad value is decreasing is by adding more users, and so that becomes a race, right, You're trying to add more more pairs of eyeballs to your service so that the decreasing value of the web ads is offset by the number of people who are

looking at it. So, in other words, if you can, if you can add more people, you make it up in volume, as they all as the old joke goes, if you can add more people looking at this stuff, then even though the value per ad is or ad impression is dropping, you've got more impressions. You're balancing it out. But you can only keep that game up for so long.

So there's some serious questions about what is the long term help for Facebook, because if the AD value continues to drop, or even if it plateaus at a really low level, how can Facebook continue to grow in revenue grow as a company. A lot of companies um success is measure hear in how much it grows year over year. If you have a company that has got a good, sustainable business and is making a steady profit year over year, that's fine, But the value of the company doesn't increase.

It just stays steady. And a lot of the a lot of the key psychology and investment is that you want your investment to grow over time. You want it to increase in value. Um you may not care for the idea of just being paid out dividends over a long period of time. You want to be able to see that that thirty eight dollar share you bought is

now valued at fifty dollars. So the uh, the problem is that if this web ad value continues to decrease, or even if plateaus at a low level, then what does Facebook do in order to create more revenue, create growth and actually succeed as a public company. And frankly, we don't have an answer for that. Really, what needs to happen is some sort of innovative approach to generate new avenues of revenue into Facebook so that um, they

can they can they can continue to grow. And part of the issue is also that there is now this move towards mobile platforms which has been happening over the last couple of years, but really seriously picked up. I'd say since the iPad came out, but you know, the iPhone definitely launched it. And really Apple is responsible for this move more than any other company I think, uh,

not the only one responsible, but is chiefly responsible. Well, you now have this this area where mobile, the mobile experience is really important, and Facebook is really not doing so well delivering mobile ads. It's it's even it's it's

less effective than the web browsing ads are. Well, that's a serious problem because if user behavior is moving toward a mobile platform and you are not able to take advantage of that, and meanwhile, your established platform where you are doing better, is starting to lose eyeballs because everyone's looking at it on their phone or tablet instead, You're really you're really at a losing proposition there, and in fact, um, depending upon whom you ask, this could mean a serious fallout,

not just for Facebook, but for other companies as well, because so many web based companies are dependent upon web advertising. If it falls through for Facebook, it could become a domino effect and fall through for a lot of other sites. And that doesn't mean that the entire web disappears. Overnight,

or that companies go belly up. But it does mean that um that it would be a pretty nasty shake up for a lot of a lot of companies out there, and they would have to find new ways to generate revenue that would still um encourage users to to continue

coming to their their site. For example, let's say that you were running a web video company and you generate web video and you show it online, and you make money through video ads that are placed before your role, so pre roll ads or perhaps advertising that's around the that's that's on the same page as wherever your videos are hosted, and that's how you make money through those

ad impressions. And let's say that the value of the ads just drops through the floor to the point where there's no way you can make back the money that it costs for you to produce that content just through advertising. If you don't come up with another way to get people to come in, then your company folds. If you're small enough, you know, if you're a large company, then you might be able to weather that for a while

and coast until you can figure out something else. But the only real alternative most of these companies have right now is to go to the subscription based plan where you have users pay for either a per instance or per unit of time to get access to your content. And frankly, only a small percentage of content companies out there I think are capable of doing that and maintaining

uh sustainability. Yeah, because a lot of companies out there, even if they're creating great content, it's so hard to convince an internet based audience to pay out of pocket for that content. It's not impossible, but it's really challenging because we're so used to getting content for what appears to be for free. Yeah. Yeah, well I was a social model really that goes back to the earlier days of the Internet, and it just sort of has been.

And despite despite people's valuation of subscription to something based on whatever it is that they're paying for it, um, people still believe to some degree that information should be free. So you know, it's like, well, I'm not I'm not gonna pay for that. It's you know, the app economy. I'll pay four dollars for or, you know, a magazine, but I'm not going to go pay for an online

subscription to that magazine because you know, it's not worth it. Yeah, it's so we'll see if Facebook is able to uh to one, get through this scandal without too much more trouble. This is not the smoothest I p O I've ever seen.

And then two, if they're able to either create a more effective web advertising experience so that way it reverses this trend where ads values are dropping, or if it comes up with a new way to generate revenue that is still not just effective, but it doesn't turn users away. That's that's a big question. And in fact, you know,

I certainly don't have the answer. I mean, there are people way smarter than I am who have dedicated years and years and years of study and experience to examining these sort of problems and coming up with potential solutions. And frankly, I mean my hat is off to him because I honestly can't fathom it. Yeah, of course it didn't happen. It didn't help things much that Mark Zuckerberg sold more than a billion dollars worth of stock early on, apparently to pay US taxes, And boy, am I glad

I'm not in his tax bracket. Um. Also, he's got to pay money on that for taxes, does he I'm sure he'll find that out. Yeah. Anyway, wait, I needed so I need one point two billion dollars with the stuck so I can pay my taxes and the tax on the stock. Yes. Also, Morgan Stanley was talking about the possibility of adjusting the I p O price after the fact, giving refunds for to make the price more fair.

Right that I did. I'm glad you brought that up, because I did see that this morning, that Morgan Stanley was talking about us offsetting that so that the investors who went out and bought Facebook at thirty dollars a share might be compensated somewhat in the difference of the value of what the share was when it hit the floor and what it was in you know, real world terms. Yeah. Now, if that happened if they bought stock on say, you know, Tuesday, after the I p oh that that's that doesn't count.

We're talking about actual the opening of trading. I should also say before we wrap this up, so, uh, we started recording this podcast just as trading was beginning, and the NASDAC actually a little bit after trading had begun. Uh. And since I've had the stock price up the whole time since we've done that, it has started off at thirty two point oh six, I believe this morning. Yeah, that's what That's what I think I said. At the

beginning of this podcast. It was definitely over thirty two is currently standing at thirty one point seven six, so it's down almost well three that's uh but that's just in the duration of a podcast. You should keep in mind that stocks fluctua fluctuate wildly sometimes and it's also dependent on other stuff going on. It could be it could be at the end of this the day, it could be that it ends up being up a dollar. I mean, there's just there's there's nothing to indicate in that.

You know, a four percent drop or three point eight percent drop in the duration of a podcast means nothing. And uh well, I mean, just just as an instance, people have said that Facebook stock prices directly affected Zinga stock price. Zinga being the games developer that hosts a lot of its social games on Facebook UM and now on zinga dot com that is tied to Facebook, using Facebook's log in and UH credits system to pay for in game enhancements and stuff like that. UM Zinga had

its I p O earlier this year. Um, and it was somewhat disappointing in some people's eyes. But um, the Facebook fallout has also affected ZINGA stock price. Um. So anything, I mean, all sorts of things will happen that will affect it. World news may affect the stock exchange. Um. Something that happens in this sector, like a computer manufacturer deciding not to make a particular product line might affect

everyone else is there. Stock may go up or it may go down because they say, well, if if they're going to stop making them, then the whole market is and you know these guys also, you know, it's all intertwined with all sorts of weird stuff that goes into the way one trader happens to approach them. Yeah, it can get the typing of extra zero when they're placing a cell order. Yeah, there's some sometimes billions. Sometimes sometimes things that seem um kind of ridiculous can affect it.

I mean, like to the point where you're like I can't see it in obvious connection or that's just purely psychological, but hey, that's how we humans work. And a lot of it is speculation. So all right, well I speculate we have run out of things to say on this topic. Yeah, I think you're right, all right, um speculation all right. So guys, if you have any suggestions or requests for topics that you would like to hear us cover in future episodes, please get in contact with us. You can

let us know on Facebook or Twitter. Are handled there is tech stuff H s W or you can go and send us an email that addresses tech stuffs at Discovery dot com and Chris and I will talk to you again really soon for more on this and thousands of other topics because it has staff works dot com brought to you by the reinvented two thousand twelve camera. It's ready, are you