A lot has been said and written about the facebook ipo since its debut, but investors are still confused. here are five myths about the company and its stock
The Facebook IPO didn’t live up to expectations?

The right question to ask would be “whose expectations?” Retail investors bought a piece of Facebook not because it made economic sense but for the satisfaction of ownership of a (very small) piece of a very popular company. The IPO’s initial dynamics are a direct consequence of:

An initial overpricing, very difficult to justify by the underlying economic reality of Facebook.

A game of supply and demand: The underwriters sold to their clients potential scarcity of shares available. In fact, in the days before the IPO they chose to increase the total number of shares to be sold by 25%, maximising the total dollar amount raised but increasing the selling pressure once the IPO is out. Watch out though. The total of 180 million shares sold during the IPO look small in comparison to the flood of over one billion shares that Facebook insiders will put on the market by November this year!

Facebook concealed information pertaining to its growth prospects from investors

No, many issues (for example current slowdown of sales growth, actual use of money raised by the IPO) were in fact disclosed. Many investors didn’t bother to look at the disclosures and then were surprised when they came out in the news.

Facebook has a great business model

What I’m sure about is that just by making cosmetic changes like introducing the Timeline, Facebook won’t be able to reverse its decline. Moreover, the lack of innovation that demonstrates such a change casts doubt on the ability of Facebook to innovate on its business model. A lot of signs seem to prove that Facebook has reached its zenith. Economics, digital or not, follows market rules. Launching a start-up without a strong business model can’t work eternally. Mark Zuckerberg says “Facebook was not originally created to be a company. It was built to accomplish a social mission – to make the world more open and connected ... Simply put: We don’t build services to make money; we make money to build better services.” But, today, Facebook’s survival relies on advertising income which makes up for 85% of total revenues.
With so much money at its disposal now, Facebook will easily innovate on its business model

One must realise that out of the $16 billion raised from the IPO, only $6.84 billion went to the company directly. The rest of the proceeds were used to allow investors, from earlier financing rounds, to cash out a (substantial) part of their stake. So how will Facebook use these $6.84 billion? Many commentators suggest Facebook will embark on an aggressive acquisition strategy, supported by the company’s cash (around $4 billion) and the existing $5 billion credit lines. This is probably a likely outcome, however, the true financial capacity of Facebook is going to be constrained by an upcoming tax liability linked to the settlement of restricted stocks – part of the 2005 executive compensation plan. The resulting tax liability, estimated to be around $4.6 billion, means that in the end less than $2.3 billion out of the total $16 billion raised by the company will actually benefit Facebook’s operations.

Google and Amazon.com were also downplayed by investors when they debuted at the bourses. Going by that, Facebook will also bounce back

The problem is not to know if Facebook is a great company but if it is a great investment. At current pricing it will have to deliver very strong economic performance over the next few years in order to justify the pricing of its shares. Should Facebook face growth issues or fail to maintain top profitability margins, then its shares will not follow Google’s path. Facebook will have to first establish a solid, sustainable business model (as Amazon did). Until it finds a model that can grow with the company’s aspirations, its shares are likely to remain under pressure.

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Source : IIPM Editorial, 2013

An Initiative of IIPMMalay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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