By Barry Ritholtz – May 22nd, 2012, 7:21AM
What a piece of work is a man, how noble in reason, how
infinite in faculties, in form and moving how express and
admirable, in action how like an angel, in apprehension how like
a god! the beauty of the world, the paragon of animals—and yet,
to me, what is this quintessence of dust? Man delights not me—
nor woman neither, though by your smiling you seem to say so.
-Hamlet, Act 2, Scene 2
Ahhh, the delicious cruelty that is irony! The ineffable loss, the sadness at the sudden realization that this was your own doing — an easily preventable mistake, that harsh painful sensation in the pit of your stomach when you realize that you have no one to blame but yourself . . .
Our story so far: Facebook, a wildly overvalued momentary internet phenomena led by an arrogant 28 year old man-child, decided to treat the process of going public with the same respect they do their users’ privacy, which is to say, with none at all. So they went public more or less unlawfully over the past two years, allowing 1000s (or more) outside investors to acquire substantial stakes via secondary markets from their employees and early investors. Note this is within the company’s control, and could have been stopped, but they elected not to do so. When the clamor to dump shares overwhelmed these markets (but not the hype surrounding them), FB decided to do what was described as an IPO, but was in all actuality a secondary.
Flattered and cajoled by the bankers and wankers at Morgan Stanley and Nasdaq respectively, the man-child allowed the Facebook secondary to be bungled by these once-great-now-shite financial firms.
How?
Let’s begin with Morgan Stanley, who wildly over-priced the offering price (and size) by about 4X. They were hemmed in by the inefficient, opaque, clumsy secondary markets that had originally over-priced FB’s shares. Forget $25B, had Morgan Stanley told the man-child and his team that a $40-50B cap was more than reasonable, they would not have gotten the deal. Hence, the once esteemed bankers, down from $100 in 2000, now trading at a paltry $13, have become a shadow of what they once were and were worth . . . So they took the deal.
Then, while Facebook was on the road presenting to institutional investors, Morgan Stanley’s consumer internet analyst actually cut revenue forecasts for the company (Basis: FB’s latest SEC filings).
I cannot recall that ever occurring during an IPO roadshow.
With the stock over-priced due to the secondary markets and relentless media hype, and the lead underwriter telling the company what they wanted to hear, the next decision was to hand over the stock to an exchange. The choice was between two utterly corrupt institutions — the NYSE or the Nasdaq. Given that both entities had sold their souls long ago to the HFT traders, with their co-located servers and algorithms, it looked like the choice didn’t matter all that much, since each appear to screw over investors equally, allowing front-running by HFTs and other should-be-illegalities to occur.
With the benefit of hindsight, we can see that the Nasdaq was the wrong choice. Without a specialist to deal with the onslaught of 1000s of spoof quotes per millisecond via HFT algorithms, their systems was overrun by the bots. Here is the FT’s take:
“The question now will be: was Nasdaq the victim of catering to its best customers, the high-frequency dealers who provide the liquidity that attracts investors to the market, who wanted to keep cancelling quotes at millisecond increments during IPOs?The rationale for the design of Nasdaq’s IPO cross system was that IPOs, unlike normal opening and closing auctions, have no pre- or after-market trading. Therefore, IPO prices could fail to reflect where the market really stands, and add risk to market-makers.
The irony here is that Nasdaq has also been among the exchanges leading the charge to try to damp down excessive cancellations, in cases when there are more than 100 quotes per actual trade executed. In the case of cancellations, it is traders’ software – their algorithms that make trading decisions – that is in question; whether poor design makes them wasteful with their trading messages.”
What was that about HFTs being there to add liquidity? (Please tell me that the FT was being snarky).
Nanex explains this further:
Only High Frequency Traders (HFTs) can cancel quotes at that rate. And ironic enough, it was mostly HFTs that benefited later when Nasdaq quotes stopped coming from the Securities Information Processor (SIP) which transmits quotes for everyone who doesn’t get the premium direct feeds. The nearly 2 hour outage, from 11:54 to 13:50 (See Charts at link). Those who are co-located and get the direct feeds, namely HFTs, didn’t experience this problem, as trades continued to come from Nasdaq.
So even the choice of exchange worked to screw this up yet further. While the NYSE still engages in the same sort of HFT shenanigans Nasdaq does, the specialist could have controlled the high frequency firehose, electing to turn it off (or just ignore it) in order to make an orderly IPO market.
Thus, what we see are a series of bad decisions made by Facebook’s executives going back many years. The insiders got greedy, too clever by half, in how they used secondary markets. They picked a bad banker and an awful exchange. The stock broke syndicate on Monday morning, and I would not be surprised to see it eventually cut in half from the way-too-high offering price.
Compare the Facebook IPO with that of Google — there is a world of difference between the business models, earnings at IPO, valuations and multiples. Een the Dutch Auction process Google championed had worked out well for all involved — especially retail investors.
What a piece of work is man, indeed . . .
Previously:
Less than meets the eye at Facebook (Washington Post, February 11 2012)
Facebook’s IPO: What does it mean for you? (Washington Post, May 16 2012)
Sources:
Facebook IPO: How HFT caused the opening delay, and later benefited at the retail customer’s expense
Nanex, 18-May-2012
http://www.nanex.net/aqck/3099.html
‘Raindrops’ raise questions after Facebook IPO
Telis Demos in New York
FT.com, May 21 2012
http://www.ft.com/intl/cms/s/0/c1e84ac6-a2c8-11e1-826a-00144feabdc0.html
Morgan Stanley cut Facebook estimates just before IPO
Alistair Barr
Reuters 12:19 a.m. CDT, May 22, 2012
http://www.chicagotribune.com/business/sns-rt-us-facebook-forecastsbre84l069-20120521,0,5871771.story
