Glenn Solomon is a Partner with GGV Capital. Some of his recent investments include Pandora, Successfactors, Isilon, Domo, Square, Zendesk, Quinstreet and Nimble Storage. His personal blog, focused on growth stage entrepreneurs who are thinking big; can be found at here.
It’s finally happened. Some fourteen and a half months after its IPO, Facebook shares closed on Friday above its IPO price of $38/share for the first time since the date of its IPO. Investors who bought shares in Facebook’s IPO and held until now are a whopping 5 cents in the money, with Friday’s $38.05 closing price.
The challenges of the Facebook IPO, primarily the company’s lowering of revenue guidance while marketing the deal and the NASDAQ trading glitches, are well chronicled. The IPO was clearly not executed well. Now that the company is back to the $38/share starting line, however, it’s a good time to take a step back and distill lessons from the IPO and Facebook’s last 14 months as a public company.
The Journey Influences the Destination. I believe Facebook shares would be much higher today, probably closer to $45/share, had the company priced its IPO lower, at $20-25/share, and started with lower revenue guidance. While I can’t prove this, I’ve spoken to several public investors and other buy & sell side experts, and most agree. Had Facebook priced its IPO lower, it would have signaled powerfully to the largest and most long-term oriented institutional investors that the company was seeking to attract and retain these investors by allowing them to initiate positions in the stock at an attractive entry point. Similarly, had Facebook kept financial guidance more conservative, potential IPO buyers would have gained comfort that Facebook was leaving plenty of slack, allowing for future earnings outperformance and guidance raises, despite future environmental uncertainties such as mobile. The net result of this approach would have been an initial book of IPO buyers more concentrated among the largest and best (ie, most long-term oriented) institutional investors.
The likely rush of retail buyers into the stock would have undoubtedly ensued, but the notorious fickleness of retail buyers would have been much less tested had the IPO price been lower, despite whatever uncertainties were cast over the market by the NASDAQ trading glitches. A better book of institutional investors and less jittery retail investors, all of whom would have had lower average costs to their Facebook positions, would have led to less initial tumult and shareholder turnover. Additionally, starting from a lower level of financial guidance, would have given Facebook more room to delight shareholders with outperformance, solidifying the shareholder base rather than prompting huge investor turnover.
Facebook is a once-in-a-generation company. Add the story line of an attractively priced IPO, a strong and loyal shareholder base from day one and a company that weathered the early mobile uncertainty well because expectations were set lower, and the net result points to a much higher stock price today.
Predictability Trumps All Else. Facebook is a remarkable company that would be nearly impossible to replicate. The revenue and profit growth the company has achieved have been matched by few other companies in technology over the years. Despite these unique qualities, Wall Street seeks predictability above all else. The life of a fund manager is complex. Large cap growth fund managers have a few hundred companies they can trade. At any one time, the typically manager will only follow closely about 30-40 companies in her universe and own 10-20 of them in size.
In short, there is a lot of competition for her time and attention. The easiest way to turn a fund manager off is by missing numbers and not raising guidance. Once she has lost faith in a company’s ability to clearly predict its future and guide accordingly, her attention will be very difficult to regain. Although Facebook has had many strong quarters since going public, particularly lately, the company started public life on rockier footing. The strong emergence of Facebook’s mobile usage had a negative connotation initially because investors were concerned with mobile monetization and, hence, Facebook’s ability to keep up with financial projections. The narrative would likely have been much more positive had Facebook kept more slack in the system, giving investors more confidence that core web Facebook usage would cover revenue and profit estimates for some time, while mobile growth and mobile monetization remained as looming upside to the story, not a requirement to hit forecasts.
The Perils of the Silicon Valley to Wall Street Hand-off. Facebook’s utter dominance of the social networking arena and its growing importance in the internet advertising market, leading to jaw-dropping revenue and profits, drove private market sales in Facebook up ever higher in the years and months leading up the company’s IPO. What tends to excited Silicon valley venture and cross-over investors – rapid growth, very large market opportunities, great teams and competitive advantage – typically underpin the investments made by public institutional investors as well.
Public market investors can trade in an and out of stocks every day, however, enabling for constant comparisons of one company’s stock versus another. As a result, Wall Street public investors tend to focus on price as another variable much more intensely than Silicon Valley investors. The signal coming from the pricing of private market trades of Facebook’s stock leading up to its IPO, many of which were done at very high prices, was of limited value when predicting what public investors were willing to pay for Facebook early on. Everyone knew (and still knows) that Facebook is a remarkably attractive company, but valuation was the key component missing from the Silicon valley analysis relative to Wall Street.
Entrepreneurs running private companies face challenges similar to public companies like Facebook. Each successive financing round represents a chance to recruit new investors. Deciding who is the right fit is key. The best investor relationships are long term in nature. Entrepreneurs need to listen to the market, but taking top dollar isn’t always the best answer. As Facebook has shown us, sometimes pricing a financing at or near the top of what the market will bear, can have near calamitous implications.
Still, one of the best elements of the 14 month roundtrip Facebook has taken with its IPO investors is a reminder that Silicon valley is full of comeback stories. Facebook is undeniably a remarkable company. While its management team may have made some mistakes navigating its IPO, this same team has remained incredibly focused on building Facebook into something even more special. Perhaps the next 14 months will reward IPO shareholders for their patience.