Aqueous Digital

Facebook facing action in the US courts over ‘misleading’ IPO

Facebook could be in for a rough ride in the USA where a recent ruling by District Judge Robert Sweet in Manhattan cleared the way for investors to sue them.

The main claim is that “the banks running its IPO were wrong not to disclose their projections about how the firm’s lack of returns in the mobile market and other issues would affect future revenues.”

The argument from Facebook was that they had no requirement to disclose these projections but the Judge held with the lawyers for the IPO investors and agreed that, given the statements and projections about mobile growth by Facebook prior to the IPO, this was fundamental to the public offering.

In the run up to the float in 2012, we wrote a series of articles about the forthcoming IPO, most significant of which was entitled Facebook: Over hyped? Over valued? Over subscribed? In which we questioned the revenue figures stating;

The biggest concern for potential investors focuses on whether Facebook can maintain its growth in advertising, which contributed 85% of the $1bn profit generated in 2011.

As the shares floated they went from an opening day price of $38/share in May 2012, which had been hiked before floatation from $28/share, down to a low of $18 by August 2012.

The fact that they have grown consistently since then is not deterring the class action investors as their issue is with the immediate aftermath of the float, especially as the shares didn’t recover to their float value until over a year later in August 2013.

The way it was handled was a huge cause of concern at the time and as early as June 2012 there were reports of a Canadian class action being mounted over the way the float was handled. Investors were outraged over the way the revenue expectations were made available within banking circles but not disclosed to the wider investing public.

The problem was that to the ordinary user of Facebook, some of the shortcomings were quite clear. For example it was obvious that mobile usage was surging; they even said so in the prospectus, but they omitted to state very clearly that there was no real way of monetising this growth. In fact the advertising was pretty much confined to the desktop platform and every user that chose to browse on mobile was an eyeball that was missed.

In a post in June 2012 we reported that the float had been dubbed;

the worst IPO of the decade (or ever depending on which papers you read)

The outcry following the float and subsequent sinking of the share price led us to write;

The IPO was useful in that it forced a number of things into the open and chief amongst these is the admission that the firm is almost entirely dependent on their advertising revenues, and they have no way of extending that to the mobile platform. This clearly is a business model built on sand.

This, it seems, was the crux of the problem and indeed the main thrust of the current class action. Without mobile revenues, the firm was doomed to failure and without a doubt, this did have an effect on the share price in the months immediately following floatation.

Facebook were, of course, trying to counter it and did announce a new mobile product ‘Sponsored Stories’ in June 2012 but it didn’t really hit the mark. In fact, it wasn’t until later in the year when ‘in stream’ advertising appeared that revenues started to move in the right direction taking the share price with it.

So, on this basis investors are looking for damages from having traded in shares as they fell below the IPO price, at one stage dropping to under half the value. They are not alleging any fraud in Facebook’s behaviour, but they are pursuing the case as the Judge said that the investors had a right to do so because “an issuer has a duty to disclose any trend, event or uncertainty that is “known and existing at the time of the IPO” that “was reasonably likely to have a material impact” on the issuer’s financial condition”.

This will be an interesting case to follow and one we will return to at some time in the future no doubt.

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