Introduction to IPO

An IPO refer to initial public offering of securities made by a company. The companies opt for IPO to raise money from the public at a big platform. A firm getting listed on the stock exchange and raising money from the public by issuing securities for the first time is said have launched an IPO (Khurshed, 2011). Facebook got listed for the first time in the year 2012 and brought its IPO in the market to raise money from the public.

There are various benefits and drawbacks of going public and raising money from the public. The biggest advantage is that the company gets access to the larger capital market where it can raise money in huge sums to finance big capital projects (Khurshed, 2011). Further, the company is also benefited from the publicity it gets after getting listed on the stock exchange. The company’s market image and brand value tend to rise when its securities are listed on the stock exchange. The investor reliance and faith is increased because the company becomes obliged to comply with various legal and statutory requirements after getting listed on the stock exchange (Khurshed, 2011).

However, along with advantages, going public also brings some drawback as well. The company is subjected to numerous compliances which results in increased cost in terms of legal compliances (Siddaiah, 2011). Further, the control of individual group of owners is also gets diluted as the shares are issued to the public at large. Thus, the dilution of control and the increased cost of capital are the main drawbacks for a company going public (Siddaiah, 2011).   

In the case of Facebook, first reason that the company had to go public was the legal requirement of sec rules. The sec rules state that a company having assets of worth $10 million or more and shareholders exceeding 500 is legally required to get listed. The Facebook was caught by this rule in the year 2012 so it had no option but to get listed (Maeseneire and Divakurani, 2012). Apart from this, the company needed large sum of capital to invest in the research and development project which also laid it to public. Further, the company also gave its employees stock option plans to retain them for longer period so in order to meet the requirements of employee stock option plan it had to get listed (Maeseneire and Divakurani, 2012).  

Benefits and Drawbacks of Going Public

There are various options available for a company to raise money which includes several debts raising options and issuing shares to the public. The choice of option to raise money depends upon the circumstances in which the company operates (Brigham and Ehrhardt, 2016). Facebook also had choices available in its hands but the circumstances led it to go for IPO. Facebook was in need of a sum of $100 million which is a huge sum. Facebook went to its lenders who showed their inability to sanction line of credit. The lenders of Facebook were under pressure after the 2008 financial crisis and due to tightening controls of the credit market they denied to lend money to the company. Further, the private investors of Facebook namely TriplePoint Capital also showed reluctance in investing in the company’s stock. So, the company was bound by the circumstances to go public and launch IPO.  Apart from this, the initial valuation of the stock of Facebook also looked quite promising which also encouraged the company to go public and launch the IPO (Maeseneire and Divakurani, 2012).         

Thus, at that point of time and circumstances in which Facebook was operating it was considered easier for it go public and raise money from the market rather than going for line of credit from the lenders. The company was triggered by the sec rule so by any means it had to get listed even if it was not to raise money through IPO. So, after getting listed it was quite easy for the company to launch the IPO. Considering the circumstances, it could be articulated that launching the IPO to raise money was the suitable choice for the company.   

As per the rules of listing, the company issuing prospectus to raise money from the public has to disclose the proposed use of the proceeds. The company makes disclosure in this regards in the prospectus so that the investors could know the purpose for which their money would be utilized (Khurshed, 2011). Complying with these disclosure requirements, Facebook also made disclosures in the prospectus. The Facebook estimated the proceeds from initial public offering to tune of $6.80 billion (Maeseneire and Divakurani, 2012). It disclosed that the use of these proceeds will be made primarily for working capital purposes. It further disclaimed that at present the company do not have any specific objective of deploying money on any project. The company also disclosed in the prospectus that it may also consider investing the residual proceeds in the interest bearing securities with grade-A credit rating which comprises money market funds and certificate of deposits (Maeseneire and Divakurani, 2012).

Motivations for Facebook IPO

The use of proceeds as disclosed by Facebook does not seem to be promising form the investors view point. The investor look for use of proceeds in the profit generating projects but the company is considering the use of proceeds for working capital and investment in interest bearing securities. However, the investment of proceeds remaining after use in the profitable projects is desirable.     

Initially, Facebook lunched IPO with 421 million shares at a price of $38 per share which amounts to nearly $16 billion. However, through the green option provision, the number of shares was increased to 484 million which implies that the company raised around $18 billion from the IPO launch. Thus, it would not be correct to state that Facebook raised $16 billion from the market through IPO (Maeseneire and Divakurani, 2012).  

The stock is divided into different classes to provide for separate voting powers to holders of different classes of stock (Mantysaari, 2009). So, in the case of Facebook, the IPO offerings were segregated into class-A and class-B stock. The holders of class-B stock would be controlling the affairs of the company more prominently as compared to the holders of class-A stock. Mark Zuckerberg was allotted class-B stock and other subscribers (public at large and employees) were offered class-A stock. Thus, by allotting himself class-B stock, Mark Zuckerberg was able to exercise control over the affairs of the company. Mark Zuckerberg holds 28% class-B stock which is equivalent to 57.30% holding in the company. Thus, even after IPO, Mark Zuckerberg holds controlling interest in the company which gives him power to take decision in relation to maintaining affairs and running the business (Maeseneire and Divakurani, 2012).      

Underwriters play a vital role in the initial public offering made by a company. The company gets into an agreement with the underwriters to administer the issue of stock to the public. The underwriter manages the entire issue and they also undertake liability to acquire the stock remained unsubscribed by the public. For this arrangement, the underwriters charge a fee or commission which is decided by an agreement between the company and the underwriters. In the cases of IPO, the underwriters performs activities like determining the issues price of securities, buying the securities from the company, and issuing these securities to the public for subscription. Thus, the role of underwriter is akin to that of an agent. The underwriters of IPO issues are typically the investment bankers who possess the qualities of finance expert and they guide the company in managing the issue. Further, the underwriters are also experts in ensuring the regulatory compliances relating to the initial public offerings. Thus, they also provide regulatory compliance services to the company.

Use of Proceeds from IPO

The probability of an IPO being launched and implemented successfully in a timely and hassle free manner depends upon the efficacy of the underwriters. Thus, the company should pay attention while choosing the underwriters to an issue of securities. The primary considerations in selecting an underwriter for an issue would involve expertise, experience, and the knowledge of the underwriter. The goodwill of the underwriter in the market place in terms of getting the IPO launched successfully is also a matter of consideration. Apart from this, the fees charged by the underwriter would also be there in the considerations in selecting the underwriter.  

An issue of securities that involves huge sum of money requires syndication of the underwriters. The syndication of underwriters refers to formation of a group of underwriters wherein two or more than two underwriters come together to administer and manage an issue. The main motivation for syndication is the diversification of risk. An underwriter bears the risk of under subscription of the securities by the public. This risk of underwriter gets diversified through formation of syndication. Further, it also facilitates hassle free and timely launch and implementation of the IPO.   

The issue price of the stock of Facebook was determined to be $38 per share for the purpose of launch of IPO (Maeseneire and Divakurani, 2012). This issues price was higher than what was suggested by the valuation done applying discounted cash flows and comparable company analysis. The discounted cash flow valuation technique provides for valuation of the stock based on the discounted value of the free cash flows available to the firm (Krantz, 2016). The valuation as shown in the figure-2 given below indicates that the price of stock is $28.69. Further, the results of comparable company analysis showed that Facebook was not performing above average comparing it with the peers. In the figure-1 given below, Facebook could be observed to be the second lowest performer in terms of revenues and EPS growth after Zynga. Despite being the below average performer, the analysts valued Facebook at higher price. The price to sales ratio of Facebook in the year 2012 was 11.15 times which was highest among the peers. Facebook was considered to be more valuable firm than the star performer among the group Linkedin.   

The valuation done applying discounted free cash flow technique by Prof. Damodaran was for class-B shares only. The valuation should have been performed for class-A shares also. However, the valuation was done properly in all respects except that the growth rate applied on revenues seemed to be a bit higher. Prof. Damodaran used growth rate of 40% for the first 5 years and then reduced it gradually over the period of next 5 years (Maeseneire and Divakurani, 2012). The growth rate applied in the first 5 years looks higher and there is the possibility that the company might not be able to achieve this growth. Thus, as a result the valuation done by Prof. Damodaran could result in overvaluation of the stock.   

Mark Zuckerberg’s Control over Facebook

Facebook was listed on the stock exchange with the issue price of $38 on May 18, 2012. It was claimed by many experts and analysts that the issue price of stock is overvalued and the impact of this overvaluation would be perceived soon after the launch of stock. The claim of these experts and analysts was proved to be right as the stock price of Facebook fell down immediately on the next day (Maeseneire and Divakurani, 2012).  However, the performance of the stock on the day of opening was noticeable as the stock rose up to $45. On the very next day, the market value of the stock went severely down by $11.03 billion which shocked the investors (Maeseneire and Divakurani, 2012). The drop in the stock’s price caused rise of suspicion in the minds of people about the achievability of future growth. So, the stock traded downside in the first 90 days after the launch of IPO. The company declared its first quarterly performance after listing in August 2012, which caused the stock to decline further. The quarterly financial performance of the company was down compared to the previous quarter resulting in loss of patient among the investors.

Therefore, in the short term, the performance of IPO of Facebook was not good. However, with the efflux of time, the performance improved and the stock showed tremendous growth for the investors. From the chart shown above, it could be observed that the stock rose to $150.24 in the year 2017 from $38 at the time of launch of IPO. In percentage terms, the stock grew by 295.37% over the period of 5 years providing handy return to the investors.

The chart shown above presents the performance of Facebook, Google, and Amazon over the period of 5 years after launch of IPOs. Google seems to be best performer among three. However, the price of Google are fluctuating and looking more volatile than Facebook and Amazon which signifies higher risk. Facebook’s stock trend line depicts that the rise in stock had been with stability. Facebook’s stock started rising rapidly in the second year while the stock of Google started in first year itself. The stock of Amazon picked pace in the third year. So, the patterns of the three stocks are different. The notable point here is that the stock of Facebook grew with stability and showed a study wealth creation for the investors (Walters, 2017).

The capital structure of a firm is made of component such as equity, debt and preferred capital. The analysis of capital structure is necessary to assess the solvency risk and the company’s ability to perform better in future (Baker and Martin, 2011). In regards to Facebook, the analysis of capital structure has been given in the table below:

Capital Structure: Facebook
					$ Million
	2013	2014	2015	2016	2017
Debt	2425	4088	5189	5767	10177
Equity	15470	40184	44218	59194	74347
Debt to Equity	15.68%	10.17%	11.74%	9.74%	13.69%

(Facebook, 2016)

It could be observed that the debt and equity both have grown tremendously over the period of 5 years showing the expansion of the business. Prior to IPO lunch, the company had borrowings but after the launch of IPO it has reduced the debt significantly. In the year 2013, the debt equity ratio was 15.68% which reduced gradually till 2016. In the year 2016, the debt equity ratio reached to 9.74%. However, with the increase in liabilities, the ratio again increased to 13.69% in the year 2017. It could be observed that the value of equity has increased significantly over the period of 5 years after the launch of IPO. Total equity was $15,470 million in the year 2013 which increased to $74,347 million in the year 2017. The increase in equity shows accumulation of wealth for the investors. However, the low use of debt indicates that the company is not reaping the advantages of leverage. If the company increases use of debt in the capital structure, the earnings of the company are expected to future increase and that would have a positive impact on the share price.

References

Baker, H.K. and Martin, G.S. 2011. Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice. John Wiley & Sons.

Brigham, E.E. and Ehrhardt, M.C. 2016. Financial Management: Theory & Practice. Cengage Learning.

Facebook 2016. Annual report of Facebook 2016. [Online]. Available at: https://investor.fb.com/financials/default.aspx [Accessed on: May 25, 2018].

Khurshed, A. 2011. Initial public offering. Harriman House Ltd.

Krantz, M. 2016. Fundamental Analysis For Dummies. John Wiley & Sons.

Maeseneire, W.D. and Divakurani, A.K. 2012. The Facebook IPO Hype: a rude social awaking. Vlerick Business School.  

Mantysaari, P. 2009. The Law of Corporate Finance: General Principles and EU Law: Volume I: Cash Flow, Risk, Agency, Information. Springer Science & Business Media.

Siddaiah, T. 2011. Financial Services. Pearson Education India.

Walters, N. 2017. 5 Years After Their IPOs: Facebook vs. Google vs. Amazon. [Online]. Available at: https://www.thestreet.com/story/14141893/1/5-years-after-their-ipos-facebook-vs-google-vs-amazon.html [Accessed on: May 25, 2018].