Timing is all – heading for the exit

I recently posted about Facebook and its Nasdaq launch in May. In the first five minutes, 100 million shares were traded and this initial frantic demand drove the shares well above their offer price to $42. However, the price fell back to end the first day of trading at $38.23. As I wrote at the time, many analysts doubted whether Facebook was worth its initial valuation.  For example, Sam Hamadeh, co-founder of PrivCo, commented that “After the first couple of weeks, I think it’ll drop back down to the mid-twenties – and that’s being generous”.

In fact Hamadeh was correct; it was generous. A closing price of $18.06 per share on 1st September represented a fall of over half from the opening day peak.  Early investors got the green light to sell Facebook shares for the first time on August 16, sending its stock down 6.3% and prompting price target cuts. With several more lock-up expirations over the next year the stock value should continue earthwards. Approximately 243 million shares will become available for trading from mid-October, with November 14 being the big day with an additional 1.2 billion shares entering the market.

So it appears that the flotation failed to match the early optimism. Certainly, there has been a paper loss for many investors since launch and the fall in stock price means that Mark Zuckerberg no longer sits in the top 10 wealthiest technology entrepreneurs, despite the fact that his wealth is estimated at $10 billion. However, for many of the initial financial backers in Facebook, it’s payback time. Peter Thiel, the ‘Angel’ internet tycoon and co-founder of PayPal, who saw the potential of the social networking idea and invested half a million dollars in Facebook, sold about 20 million shares of his shares at the end of the first ‘lockup period’, netting $400 million. Having already sold stock on the first day of trading worth $640 million, meant that his $500,000 investment had risen to $1.03 billion, a cool 200,000% return for a 7 year investment. Zuckerberg and his fellow employees cannot sell their stake until November, by which time the share value is likely to have fallen further.

It is quite common that the founders of businesses stick with their creations even when values fall. Steve Jobs at the time of his death still owned 5.5 million shares in Apple. However, unlike entrepreneurs, Angel investors like Thiel often set an early exit strategy having no emotional stake in the business and wanting a quick return for their risk and knowing the volatility of markets. The billionaire serial venture capitalist, Michael Moritz, for example, spotted the potential in, then, little known companies called Google – founded in 1998 – and YouTube, which was bought by Google for $1.65bn (£890m) in 2006. His internet company investments also included Yahoo!, PayPal, Webvan, eToys, and Zappos. The timing of his stock sales resulted in him achieving the number one listing in Forbes’Midas List” of the top dealmakers in the technology industry in 2006 and 2007 and a place on the 2007 “TIME 100″.

IB-style questions

1. Define the following terms:

  • Flotation
  • Entrepreneur

2. Explain the reasons for setting up a new business.

3. Analyse the reasons why new technology companies often use venture capitalists to fund their growth and the advantages and disadvantages of this relationship.

4. Using the following links as a starting point, discuss the reasons for the decline in Facebook’s value following its flotation and comment on its future potential.

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