Will Facebook "Go Dutch" or Stick With Traditional Wall Street IPO Approach?

A lot of buzz has recently surrounded the news of Facebook’s intial public offering, with the Wall Street Journal anticipating the launch of public shares coming as early as this spring.

It has emerged as a $10 billion deal, announced in mid-November and valuing the company at just over $100 billion. However, the company’s chief financial officer, David Ebersman has made headlines by signaling that he may not need investment bankers’ assistance with the process.

In terms of guiding the company through the initial public offering process, Facebook founder Mark Zuckerberg, his colleagues and advisers appear to have two options. The first, a conventional IPO involves Wall Street banks allotting shares to investors for a percentage of the total. The prospect that Facebook’s Wall Street debut could raise $10 billion as early as April has already sparked a furious race among investment banks in and attempt to ink a deal. The sizeable fees from such a large IPO coupled with the eternal bragging rights make this an incomparable deal.

The other option, the unusual “Dutch Auction” method, takes into consideration the company’s size, business model and popularity. Facebook stands among the rare cases of companies that do not require Wall Street in order to go public due to its popularity and solid profitability. Usually, prospective public corporations must be sold to investors by Wall Street’s banks, who lend their brands and expertise in the attempt to convince fund managers that the company is prepared to weather market storms. Instead, Facebook can potentially cut out the middleman, making the exchange of shares dependent on the prices bid by each investor.

According to sources familiar with the matter, Ebersman has said that he is skeptical about the de-valuing effect Wall Street bankers could bring to the deal. The most striking distinction between the two systems, apart from lower auction fees, is that when IPOs “go dutch,” banks don’t get an input on who acquires shares. This thereby presents investors with a rare equal opportunity with "the street".

“Failure is not an option,” one banker said in a summary of the task last week. Still there are no guarantees and with the steep competition, he asked that Zuckerberg reveal his plan, thereby putting several investors out of their misery with a polite, yet firm rejection.

Some banks struggle with conflicting loyalties, needing to pursue IPOs while simultaneously attempting to keep hedge funds and other high-paying clients content. This can result in what University of Florida corporate finance professor Jay Ritter believes to be under priced “hot” IPOs. He analyzed American IPOs for the last 30 years, discovering that those that raised the offer price above the initial range recorded first-day gains that noticeably outstripped less successful IPOs. Thus he argues that when IPOs are in high demand, banks are inclined to be sparing with companies, compelling them to raise less money so investors enjoy the escalation of shares in the first days of public trading.

However, if the process of customary IPOs is this imperfect, it seems odd that Dutch auctions aren’t implemented more frequently.

One reason is Google:

“Google made a huge splash in the financial markets by not going the traditional route in its IPO,” said Max Wolff, chief economist at GreenCrest Capital Mangement LLC, which concentrates on pre-IPO company research.

However, the most widely known and used search engine spurred uncertainty in investors by utilizing a hybrid of the Hambrecht model. Just before the IPO, Google reduced its proposed price range and slashed the number of shares it was willing to sell. Since then Hambrecht model has been almost entirely untouched.

A deeper look into the IPO process reveals that it was destabilized by factors isolated from the auction such as a waning technology market, a weak pre-IPO “roadshow” and an untimely and poorly received Playboy interview with Google’s founders.

Perhaps this will serve as a cautionary tale for Zuckerberg, especially considering his competition with Google.

“Facebook is consciously trying to out-Google Google all the time,” Wolff said. Still, the Facebook IPO deal is not quite signed, sealed and delivered. Reports of the current state of the market and the beating technology companies, such as Groupon, have taken (down 42% since its issue price) may cause the seven-year-old social network to defer its offering.

Not only would this be the largest technology IPO in U.S. history, it would assign the company a market value comparable to that of General Electric; cementing Facebook’s status as a social utility, the Web’s version of a power company.

 

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