Before reading this article, ask yourself a few simple questions:
What was Facebook’s value, at its Initial Public Offering launch?
What was Facebook’s operating profit in the previous year?
So how on earth did they reach that outrageous valuation & how does a pump and dump really work?
This question will take a little more explanation.
So you have probably already realised that I am less than impressed with the way Wall Street has handled Facebook’s IPO!
Yet again they seem to have convinced the average investor and pension fund managers to throw more money down the drain, on an asset that does not justify its price tag. Is this a pump and dump or is it just clever marketing?
Let’s think about this numerically; would a company with a profit of around $10,000 in 2011 be sold for $1,000,000 the next year?
If this proposition was put on BBC’s “Dragons’ Den”, the Dragons would have ripped the its balance sheet to shreds!
So how have Facebook managed to get this preposterous value attached to it?
Let’s start by finding out exactly what a pump and dump really is? (Courtesy of Investopedia.com)
“A scheme that attempts to boost the price of a stock through recommendations based on false, misleading or greatly exaggerated statements. The perpetrators of this scheme, who already have an established position in the company’s stock, sell their positions after the hype has led to a higher share price. This practice is illegal based on securities law and can lead to heavy fines.
The victims of this scheme will often lose a considerable amount of their investment as the stock often falls back down after the process is complete.
Traditionally, this type of scheme was done through cold calling, but with the advent of the internet this illegal practice has become even more prevalent. Pump and dump schemes usually target micro- and small-cap stocks, as they are the easiest to manipulate. Due to the small float of these types of stocks it does not take a lot of new buyers to push a stock higher.”
So the above explanation gives you the basic principles and then goes on to explain how cold calling is traditionally used as a sales method, to dupe willing investors into parting with their cash.
In my opinion, the above explanation seems pretty spot on.
However, Facebook and the bankers went a lot further to convince people of its massive price tag; they created a media buzz and I must say, hats off to the marketing drive, it almost had me convinced!
They used some the biggest banks and underwriters to launch the IPO, they did this shortly after a blockbuster movie and used their own user base to spread the news around, in almost every country in the world.
I’m not suggesting that “The Social Network” was secretly funded and made by Zuckerberg, but it certainly played a part in pushing up this historic IPO’s launch price.
Once this price tag was put on the company from subscriptions, it was pretty simple for the initial investors to dump their shares and flood the market.
Let me explain this in more detail and give you a step by step guide to what happened.
Step one: Boost the share price, by exaggerating statements.
At the beginning of a pump and dump, the company must build its reputation.
They essentially need to create demand, so that people want to buy shares in the company. Facebook and the bankers had the task of convincing all of us, that they are potentially going to be one of the most profitable companies in the world.
This was not too difficult with Facebook’s user base and following; the bankers knew that this was a prime target to pounce on and reap the benefit.
Many people didn’t ask why Facebook’s profit was only 1% of the company valuation. I’m sure the public simply thought……. “Who cares, its Facebook; I love Facebook!”
I personally can’t detract from Facebook’s user base, there are more than 840 million users worldwide and more than 55% of those users, actually log on every day; I personally log on at least a few times a week!
Facebook is no doubt a fantastic idea and truly has revolutionised the way we connect with friends and family online…….. Oh dear, they have got me saying these things too!
Step two: The Pump
Now that Facebook has made its name and has some good strong partners from Wall Street, they can begin by going hell for leather on the marketing.
If you didn’t know already, Facebook’s original partners and the insiders got their shares for between $1 – $5 per share, so its not too hard to make a large profit from this point forward.
You are right to think that some of the large investment banks got in at this price. I personally would have snapped Facebook’s hands off, if they offered me that share price.
Step three: More pumping
Now that the subscriptions are flowing and a desirable price has been set, hype up the launch further, inform the general public that the price is going up and up and it’s the buy of the century.
Unfortunately even pension accounts dropped millions and possibly billions into this stock; fingers crossed your pension scheme didn’t do this!
By the end of the marketing, the IPO confirmed a price tag of $38 per share and was officially the largest technology IPO ever; they raised a whopping $16 billion in total.
This gave Facebook a Price to Earnings Ratio of around 100!
Just for the record, an average PE ratio is around 5 – 15 and it effectively means that Facebook will take around 100 years to pay your initial investment back. Does that sound like a bargain or what?
Even some of the News channels were convinced; Jim Cramer from CNBC was saying that it could hit $70 per share in the first day…….. well done Jim, well spotted!
Step Four: The IPO’s launch date
Now you have millions of zombie followers who want to purchase the stock; open the flood gates and let the lambs come to slaughter.
The unfortunate part of this, is that a lot of pensioners don’t even know how to switch a computer on, let alone understand how to log onto Facebook and their pension money has been dropped into this IPO and flushed away!
Facebook had subscriptions coming out of their ears, the marketing was fantastic and they have hundreds of millions of loyal followers. This really was the bankers dream and they could not have done a better job.
Step Five : The Dump Begins
So how and when do the big investors jump out, how do they break some negative news and get away with it?
Not surprisingly, Morgan Stanley published an article saying that they are reducing Facebook’s profit outlook and even Facebook themselves issued an amended prospectus with the SEC, where they stated that the company expressed caution about their revenue growth, because of users migrating over to mobile devices! (See Reuters)
So literally days before the subscriptions go live, they drop a huge bombshell on the consumers and for your average Joe, it was simply too late.
The price is sitting above $38 and the insiders have a huge profit margin to play with.
This was the nail in the coffin for me, I was now fully convinced that the banks have done it again; they have duped the general public into forking over their hard earned cash. The insiders creamed between 7 – 38 times what they originally invested and were laughing all of the way to the bank ……… not a bad 3 and a half months work for Wall Street indeed!
Step six: The Dump ends
The insiders and big banks dump their shares on unsuspecting buyers and then watch the share price crash and burn over time.
Some people see this as clever marketing and some as a pump and dump. Whichever way you see it, the fact of the matter is that the bankers are triumphant and the consumer, which don’t forget includes pensioners, are worse off again!
So where does Facebook stand now?
Facebook is now valued at around $20 a share, which is around half of its original offering; in my opinion a new age pump and dump and they have gotten away with it. Its just a little better put together than a dodgy boiler room scam, because of the huge marketing budget and highly experienced Wall Street partners.
The classic adage, the rich get richer and the poor get poorer is pretty accurate and to top things off the biggest holders are pension funds all over the world. The key difference here is that Facebook are a real company with a good business plan, it’s just that Wall Street jumped on at the start and used their experience to milk the consumer.
So, do I think Facebook will go bust?
The short answer is No; they have a large following base and can make profit to stay afloat.
However, and it’s a BIG HOWEVER, they really don’t command a share price of $38 a share at the moment. Let’s see the ideas that Mark Zuckerberg has first, before putting a price tag on of that amount!
I’m just sorry for the pensioners that simply don’t know what Facebook is, let alone that part of their pension money has been lost in it.
If you honestly fear that your pension fund is not safe, please don’t hesitate to contact me right away; I have helped many expats move their pensions to QROPS and SIPPS. These structures give my clients full control of where their money is being invested.
Intelligent financial architecture is what is needed in the world today and if you don’t keep an eye on your investments, then who knows what you may be holding!
I hope that you enjoyed reading.
Kuala Lumpur : Malaysia