Facebook’s Initial Public Offering and Subsequent Financial Performance

Introduction

Initial public offering (IPO) of a company is the first sale of a private company’s stock to the public. IPOs are normally offered by small private company’s seeking capital to expand but can also be done by large private companies with an intention of becoming publicly traded. On the other hand, financial subsequent performance is the measurement of results such as returns on investment, return on asset and value added of a firm’s policies and its operations in monetary terms. Facebook’s initial public offering and its financial subsequent performance are discussed in the following essay.

Valuation And Method Used to Determine the IPO of Facebook’s Stock

In a situation where a firm decides to go public the initial step is the formation of a proper underwriting team of personnel. This team of personnel would include an investment bank in charge of underwriting the securities, the management of the firm, a legal counsel incharge of offering legal advice, and various financial consultants and advisors (Liaw, 2012). Once the terms are agreed between the firm and the investment bank, the team of personnel formed begin examining the firm and filling all the paperwork required by the security exchange commission. Valuation of the firm is the first step of setting the price. This valuation provides a starting point from which the final price for the offering can be set. The methods of valuation used by Facebook are discounted cash flows analysis.

             Discounted cash flows analysis is the most efficient and perfect method of valuing a firm. It involves accounting for a company’s future free cash flows together with its weighted average cost of capital (Vault, n.d). Dividend model and the cash flow to firm approach are among the different types of discounted cash flow analysis. This method mainly concentrates on calculating the net present value of the total sum of all the expected free cash flows.

In order to be able to evaluate the discounted cash flow, there should be a set limit for what would be the extent of calculating the future free cash flows. For companies with high growth, which are dominant in the market with high barriers to entry, cash flows are possible to be estimated accurately for a long period such as 10 years into the future. Companies with a slow growth rate and in highly competitive environments may be limited to be only able to forecast their cash flows for a period of 2 or 3 years with accuracy (McClure, n.d.). Adjusting the net income for each year is used to determine the expected free cash flows.

A miscalculation that may have made Facebook mislead their potential investors is the heavy reliability of predictions of the future cash flows. The reason for this is that future cash flows are in most cases overstated or may not account for any of the unforeseen losses in the market share for the company (Liaw, 2012). This method therefore does not provide some of the difficulties that may be faced when valuing the company. Facebook conducted an IPO when it was very young and its future cash flows were uncertain. To solve this, the discounted cash flow method should be used together with the multiples more for more accuracy a suggestion recommended by most industry leaders. According to (Kim and Ritter, 1999), they recommended that together with the traditional multiples used in the calculations, underwriting personnel should also put into consideration using other multiples which may include market to book, price to sales, enterprise value to sales and the enterprise value to operating cash flows raise the accuracy of the future value of the firm.

Performance of the Stock within the First Year of the Public Offering

May 18, 2012, Facebook held is initial public offering. In the history of internet and technology, this was seen as the biggest IPOs ever with a peak market of over 104 billion dollars. Contrary to the expectation, the stock fell as soon as it was opened and the prices of shares fell with over 50% over the following few months. For the shares to trade above the 38 dollars listing price, it took a period of more than one year.

Though Facebook made 16 billion dollars in the offering, the IPO was seen as a fall and the stock decreased with almost 50 billion dollars by the time august 2012 was reaching. Some of the reasons that may have caused this fall may be:

1. Initially the pricing of the shares was set between 28 and 35 dollars a share which was conservative but three days before the market debut, Morgan Stanley, JP Morgan and Goldma Sachs which are the underwriting banks increased the IPO price to between 35 and 38 dollars causing a large demand. This change was contrary to the agreement of the large investors that Facebook was overpriced.
2. Technical hitches were also a cause for the fall in prices of the stock as they delayed the stock opening on the day of the opening. This was the reason as to why a group of investors were not able to sell their stocks on the first day of trading when the prices kept on falling thus leading to big losses when their trades were finally sold.
3. Lack of confidence in the stock was also a factor. This was due to the fact that about 57% of the total shares sold in the IPO were from Facebook’s insiders. General motors deciding to pull 10 million dollars in advertising off the site regarding the ads ineffective
4. Ahead of the offering, Facebook also increased its number of shares to 421.2 million which was a 25% increase. This was considered a bad move as normally retail or individual investors are allocated up to 20% when the shares were overvalued as it contributed to selling of shares from the investors who were allocated more shares when profits failed to materialize as expected

Alternative Method for Valuation

Comparable method of valuation can be used as an alternative. In using comparable analysis approach, the target firms and other comparable transactions are compared. (Liaw, 2012) suggests this to be for the reason of determining the target company’s implied values in the public equity market. Valuation of a company on the basis of comparable transactions involves the examination of similar firms that have gone through the IPO process relevant metrics such as the price of securities. The primary transaction valuation parameter must be evaluated when using the comparable method. According to (Fuhrman, 2013) the value can be added to the market multiples once the parameter is determined so as to calculate the value for the company. 

In cases where there is no enough information to use the comparable method successful, use of comparable transaction method may be efficient. Facebook may have fully relied on the values of the comparable firms and transaction which may not necessarily account for the market changes. This method does not also account for the difference in the accounting methods which may have an impact on the accuracy of the multiples. To correct these errors suggests that this method should be used in combination with the cash flow method. Even when comparable firms and transactions are available, using those values does not necessarily account for changes in the climate of the market or industry (“Comparable Transaction Analysis,” n.d.). Additionally, this method does not account for differences in accounting techniques which may affect the accuracy of the multiples. For this reason, this method is often used in conjunction with the discounted cash flow method outlined above (Fuhrman, 2013).

Roles of CEO

The chief executive officer (CEO) has various roles in relationship to the stock performance which may include:

1. Balancing the strong points of view where open-mindedness and a lot of flexibility is key. The CEO communicates their clear and convincing points but also consider the board’s view which can also be applied. They give the board the option of challenging some of the assumptions they would have made and also challenges those of the board members.
2. The CEO also recognizes the power of the skills on the board, the value of a board whose individuals have skills and perspectives which are different from his. He/she feels encouraged and strengthened by board members who have skills that are superior to his.
3. The CEO also actively work to communicate and strengthen the relationship with the chairman and directors through regular interactions outside the board meetings. These interactions are not only for sharing of information but also for a strong professional relationship of the board members
4. Decision making is also one of the key roles of a CEO, he/she communicates openly, actively and also transparently to maintain a ‘no surprises’ policy with the board.

The CEO of Facebook would have maintained a ‘no surprise’ policy to avoid the increase in prices of the shares which was not agreed by the investors. He/she would also have worked harder on maintaining an effective relationship with the chairman and directors.

Risks and rewards

There are a lot of things for investors to consider before making the decision to invest in newly public company. The first step is researching the company so as to develop a clear understanding of business model and the management team. The growth and the potential of earnings should be considered and a case developed as to why it should be considered more than competition. An investor should if the company’s potential to grow is high enough to attract high returns on the investor’s investments. This avoids the risk of earning losses.

All investments have a possibility of facing market risk, which may include loss of the principal amount invested are subject to market risk, including possible loss of the principal amount invested. Shares of IPO normally do not have a trading history. They rely on speculation thus not suitable for all investors in the market. It is therefore in only in the power of an individual to decide whether such an investment is worth hi/her investment goals and within their tolerance. One should be able to read the prospectus very carefully before an investment.

Buying an IPO is one of the ways of getting to the ‘ground floor’ of any company if the investor thinks highly of the company’s potential. It may be a little bit cheaper to acquire shares for a company which an investor thinks will perform well over the long term. An investor should therefore acquire shares for a company with great potential so as to id disappointments in the future.

Facebook’s value predictions since it launched its initial public offer in 2012. The market shares collapsed after launch from an IPO price of $ 38 dropping to the floor which was benchmarked by $17.55. Facebook made op is marketing strategies which were stimulated to commercial growth through its platform. Their prediction values are estimated to slightly rise or maintain at $ 80 in the next five years. The key drivers of this Facebook performance Instagram purchase and the general ad revenues were estimated at 2266 billion in 2012. A 10% ad pricing increase could result to a 10% rise in ad revenues provided that advertisements impressions still remain the same. Rapid expected growth in Instagram revenues is expected throughout the forecasted period. 2.81billion are the expected revenues accounting for more than 10% of the company. The increasing demand for Instagram makes it very certain that the predictions will hold.

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