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Facebook's self-underwritten IPO

FB should pursue a “do-it-yourself” IPO instead of hiring Wall Street and here’s why and how

Financial trends and news by Eric Manlunas
May 21, 2010 | Comments (3)
Short URL: http://vator.tv/n/fc3

 Let me jump on the bandwagon and talk about Facebook.  Based on various media reports and a number of Facebook insiders I’ve spoken with, this uber social networking site now has close to 450 million registered users (up from 200 million not too long ago).  That is an unprecedented scale in the history of the Internet which means that this is an incredible asset they could mine and leverage if they’re planning on pursuing an Initial Public Offering (IPO) of their shares. 

Let’s do the math – for the sake of simplicity, let’s assume that only half a percent of Facebook users believe enough in its sustainability and at the same time have the financial wherewithal that they would be willing to buy shares in an IPO.  That would potentially equate to around 2.25 million potential IPO buyers (a retail brokerage shop’s dream come true).   Let’s then assume that Facebook prices its IPO around the same level where Digital Sky Technologies (DST) bought in when they invested $200m+ in exchange for a 1.96% stake in the company.  That would equate to about a $10 Billion pre-money valuation. It’s important to note that Facebook common shares have traded as high as $22 Billion in some secondary exchanges like Second Market or Shares Post and the $240 million investment from Microsoft was done around the $15 Billion range (both Microsoft & DST investments were preferred securities which carry a liquidation preference). While all these numbers seem high on the surface, a $10 Billion valuation would be approximately 10x Facebook’s 2010’s consensus revenues of around $1 Billion or slightly higher than Google’s revenue multiple of 8.1x when it went public in Aug 2004.  Although some say that Facebook’s 2010 revenues could be as high as $1.2 to $2 Billion but let’s just stick to the $1B to be “conservative.”

Of course putting a burden on the potential buyers wouldn’t be a good idea so let’s design this to be a relatively inexpensive undertaking for the 2.25 million potential buyers that Facebook would allocate (and limit) only 10 shares per potential buyer each priced at $50 per share.  That would translate to about $500 per potential buyer which doesn’t strike me as expensive for true Facebook diehards – I’m not a diehard but I wouldn’t mind participating myself just to be part of a potentially historic financing event. Just like most IPOs where companies sell anywhere from 10% to 25% of their company’s shares, let’s assume Facebook would only be willing to offer 10%, again comparable to the 7.2% Google offered when they went public (5.2% from Google directly and another 2% from Selling shareholders). 

At $50 per share multiplied by 10 shares per buyer, that would generate around $1.13 Billion for their corporate war chest.  That amount would be unheard of in any growth financing round not to mention I doubt anyone has that big of a bite size not even from large venture or private equity players.  Of course that amount can be syndicated between many large institutional investors but I doubt enough people can get comfortable at these valuation levels with those types of investment dollars.  In other words, the reality for Facebook is really just an IPO if there’s ever a need for them to raise a real sizeable chunk of growth capital.  Absent another Yahoo! type offer from Microsoft ($45B), I just think Facebook has become too large (and unique) to be acquired through conventional means.

So here’s a quick table just so you math diehards can easily verify my calculus.

           

I’m not going to get into the complexities of an IPO distribution process but given the scale of Facebook’s community, this could be less complex vis-à-vis an ordinary company trying to reach out to 2.25 million potential retail accounts.  Vonage did this when they went public in 2006.  While that may seem a bad example since the Vonage IPO failed miserably, it failed not because they tried to make their customers their shareholders, it failed because it’s a lousy money losing business.   Facebook already has a loyal captured base so it shouldn’t be that difficult to reach out to their flock (they just need to make sure they adhere to regulatory requirements).  Think “network effect.”  Imagine the PR frenzy it would generate which will lead to even more users – let’s not forget that Twitter benefited quite a bit from the “Oprah Effect.”  I suspect this will have the same effect.  I don’t mean to minimize the process – I could hear the criticisms already from Wall Street traditionalists/purists screaming that this would be a bad idea because without their involvement there wouldn’t be aftermarket support, no analyst following, no institutional base, etc, etc.  All I’m saying is this is very feasible if Facebook chooses to leverage its inherent advantages (community, technology, human network, media darling status, etc.).  By the way, Wall Street firms can still get involve post-IPO by putting their book of clients to support the stock in case most of these potential buyers turn out to be punters.

Historically, IPOs have cost companies around 6–7% although at this scale it’s going to be around 3%. Google’s $1.67 Billion IPO cost the company 2.8% in underwriting commissions or around $47m.  So assuming the same rates, Facebook should be able to save around $34 million in commissions and probably more in ancillary expenses.  Of course Facebook still has to spend on legal fees but that’s totally unavoidable in a highly regulated IPO process.  While $34+ million may seem a drop in the bucket for a company that could potentially be worth north of $10 Billion (perhaps even $20-30B), that’s still a boat load of money so there’s nothing wrong in trying to avoid that cost – why give that to Wall Street when you can put that to better use like improving the site.  This is especially true for somebody like Facebook where it already has a loyal base that would be a good source of its future shareholders.  Given FB’s unique dynamics, Wall Street firms have little to no value here.  Facebook is in a unique (and perhaps privileged) position to credibly try to “democratize” the IPO process.  To be clear, I’m not advocating a Dutch auction IPO, just a conventional one.  The only difference in what I’m advocating is the manner in which the IPO shares should be distributed.

I realize the devil is always in the details so I’ll leave the complexities of such a concept to the experts but Facebook should seriously consider going down this path as it might just create a whole new way of leveraging its most valuable asset and at the same time align its interests w/ its users.  Imagine a giant social network where its own users are its own stakeholders.  This might just give a new meaning to the expression “eating your own cooking.”


 

Comments

Lorenzo Carver
Lorenzo Carver, on May 21, 2010

That's an awesome post Eric. As far as aftermarket support, I'm guessing that tons of firms would love to be a syndicate for the shares to their retail clients just to say they did it. A lot of research has suggested that i-Banks don't make "profits" on offerings, but rather on the secondary activity anyway. Also, most of the legal and accounting work is surely being done already for a company at this scale, and that gets capitalized if they go public (so no impact on EPS). It would be great to see a company that's actually in a position to do something like this give it a try. Also, the savings could probably further offset the employee restricted stock unit overhang?


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Eric Manlunas, on May 23, 2010

Thanks Lorenzo. Hopefully the concept is taken seriously by the people who can influence this.


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Scott Anderson, on June 9, 2010

Well done Eric! Impressive numbers this example gives. Given the growing massive social media addiction I'm guessing your estimates may be conservative compared to what actually may happen. I'd be a buyer of definitely more than $500 and I'm pretty dumb and poor...

Thanks for the great analysis!

Scott


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