Why has Facebook's stock market flotation been such a disaster?

On 18 May, Mark Zuckerberg was worth $20bn. Last month that figure had fallen to $9bn. Why?

The video clip on YouTube already has the feel of a history lesson. It has taken on the atmosphere of a fateful moment, a before and after, like the signing of the Yalta treaty, or a Moonie wedding. The moment of the launch of Facebook as a $100bn public company seemed to show the myth of the American Dream in real time, visual proof that something – potentially the world's most valuable entity – had been made out of nothing, a simple idea in the head of a Harvard undergraduate. Half a year on, it looks as much an ending as a beginning.

You can see a lot of that story in the film clip, on faces gathered outside Facebook's headquarters at Hacker Square in Menlo Park, California, on 18 May 2012. Our digital age has acclimatised us to extreme numbers, the winner-takes-all lottery of wealth distribution, but rarely have we seen such a group of people instantaneously enriched beyond their imagination. The colleagues look like they have turned up on this bright spring morning to man the stalls at a high-school fete, or for a charity walk, in hoodies and T-shirts and fleeces and jeans. One second they can count their wealth in five or six zeroes, the next in eight or nine or 10. As the clip rolls and Mark Zuckerberg signs his name on a transparent Nasdaq screen, signalling that Facebook is open for trading, an excitement passes through the crowd. On the TechCrunch website there is a ticker running, a reckoning of instant plutocracy: "Ted Ullyot, general counsel, $234,181,060. Mike Schroepfer, VP of engineering, $340,141,012. Mark Zuckerberg, $20,305,226,592…" How do the people attached to these numbers look? They look happy, fit to burst.

That happiness, at that moment, extended far beyond Hacker Square. It extended to all the investors large and small who believed. Zuckerberg, 28, had long demanded faith in Facebook. And all his believers knew the story – they had all seen the movie, and most importantly they felt the insistent pulse the social network had generated in their own lives. On the clip after Bob Greifeld, chief executive of Nasdaq, presents Zuckerberg, "your visionary, your leader", with a commemorative hoodie, the world's favourite boy wonder, makes a little speech reaffirming that faith. "Here's the thing," he says in his slightly disconnected way, "our mission isn't to be a public company. Our mission is to make the world more open and connected… All of you out there have built the largest community in the world." Not surprisingly, as he speaks his colleagues have the moon-faced look of disciples at the Sermon on the Mount captured in medieval stained glass. They have been through a lot together; some, those crowded most closely around Zuckerberg, have been believers in his miracles from the start. Their rewards have come sooner than heaven.

All of the night before, news networks have accessed all areas on the Facebook campus to capture the atmosphere before the big sell-off. The Facebook workers, or hackers, as they prefer, have duly performed like children on Christmas Eve. They have given up on sleep and engaged in the ultimate "hackathon", playing roller hockey in the square, watching movies, camping out on sofas and doing bits of programming for the site, ordering in Chinese and pizza, recreating once again the essential exportable spirit of their organisation: faces illuminated into the early hours by laptop screens, buzzing on energy drinks, silently instant messaging across the room, making the world ever more connected before our very eyes.

They have not been thinking about performance cars and stupidly early retirement; they have been thinking, as ever, about enhanced user experiences and ever-cooler interfaces. Still, they are aware that for days and weeks the valuation of their company has been the subject of mass speculation. The wisdom of a Silicon Valley crowdsourced poll has produced an aggregate of the expected value of Facebook come the end of the first day of trading. The figure that has been collectively arrived at is $135.1bn– a single-day rise that represents more than a gain of one-third of the opening offer price of $38 per share. The investment bankers handling the offering, Morgan Stanley, have surely been conservative in their thinking, the crowdsourced feeling goes; they wouldn't want to risk their credibility on an inflated valuation.

There is much talk of a "pop" on the news networks: "Do you think we will see a pop?" "How big a pop do you think there will be?" The pop in question refers to the explosive growth as the stock hits the market, like a kernel of corn reacting to a hot pan. For those few cynics among the faithful – who perhaps have a working knowledge of Charles Mackay's 1841 volume Extraordinary Popular Delusions and the Madness of Crowds, or who at least had, as they like to say, "drilled down into the figures" and placed their bets accordingly – that pop was also, you guess, the sound of bubbles bursting.

Nearly six months on, those doubters with their sober analysis or contrarian instincts, who gambled against Facebook stock from the beginning, have been counting their winnings. Daniel Niles, who runs the AlphaOne Capital Partners, made millions of dollars for his investors by "shorting" Facebook the moment it opened for trading at $42 a share. Shorting involves borrowing quantities of shares and selling them at the high price, waiting for the price to fall, then buying other cheaper shares to return to the lender and pocketing the difference. Niles explained his analysis as follows: "If you looked at Facebook, the good news was you had a very public comparable company with a lot of the same issues and good things going on, which is Google. To some extent, it was like two houses on the same block… But you look at Google, and investors were valuing it at roughly six times annual revenues; and you look at Facebook, and despite it growing [only] twice as fast as Google, they valued it at about 24 times revenue… To me, this looked like a recipe for disaster, and that's why we shorted at the open." Another such investor, representing a major fund, described his decision with slightly less mathematical nuance: "My mother asked me to get Facebook shares and she has never been interested in IPOs [initial public offerings] before. A cab driver asked me about the IPO, too. That's when you want to short it."

On the first day of trading, markets reported that the share price had been propped up by Morgan Stanley, the bank that had acted as the lead underwriter in the sale on Facebook's behalf. What had looked like a major coup for the bank's Silicon Valley investment chief Michael Grimes quickly became a headache. In an attempt to defend the $38 opening price some observers suggested the bank may have spent a billion dollars buying back stock, though Morgan Stanley will not comment on the issue.

A few even among the closest circle of Facebook believers were perhaps not quite as faithful as they at first seemed. Peter Thiel, the canny founder of PayPal, who had invested $500,000 in Facebook in 2004, cashed in a thousand times that on the first day of trading. On the right side of things, as ever, Goldman Sachs, which had bought a $500m share in the company last November, sold about another billion dollars straightaway, as did Zuckerberg, in what turned out to be nice wedding gift to himself when he tied the knot with his long-term girlfriend Priscilla Chan in a surprise ceremony the day after flotation.

Even by the time Zuckerberg and Chan were on honeymoon in Rome a postmortem on the IPO and share price, which had by then fallen almost $10, was underway. It was already being talked of as the most disastrous IPO in history; and the first lawsuits had been filed. Facebook spokespeople united with Morgan Stanley in suggesting that technical glitches on the Nasdaq system, which delayed the start of trading by 45 minutes and saw investors struggle to get confirmation of trades, had damaged confidence. Major fund managers laid the blame with the decision, in the week before the IPO, to increase the number of shares being sold by 25% and to raise the asking price from a range between $28 and $35 to one between $34 and $38. A $100bn valuation had a convenient headline ring to it.

At the same time a hardening rumour persisted that those closest to the deal were party to more information than regular small-time investors. By 23 May, shareholders had filed five lawsuits against Facebook in New York and California. That number quickly swelled to around 40. On 1 June, three small Facebook shareholders – David Goldberg, Kevin Hyms and Garrett Garrison, who had invested retirement funds and lifetime savings – filed a class action suit against Zuckerberg and his company. Court records detailing their case argue that Facebook had been less than forthcoming about the fact that in the weeks leading up to flotation there had been a downgraded forecast of revenue, which had caused some analysts, even those at Morgan Stanley, to revise down confidence in the company – information only allegedly shared with major investors. Facebook and its underwriters strongly refute these allegations. The case, which will be heard on behalf of perhaps thousands of IPO believers, mums and taxi drivers among them, will also draw on evidence from the Securities and Exchange Commission about Facebook's apparent reluctance to release some key data – notably the way it counted mobile users, and the revenue it generated from them – even when pressed to do so. Facebook will argue that it displayed no such equivocation and that such exchanges were a normal part of such a process.

Andrew Goldenberg, one of the attorneys representing Goldberg, Hyms and Garrison, described how the three men came to his office "confused and frustrated and angry… They are not sophisticated investors," he said. "They thought they were buying into a company that had a promising future." Nearly 200 others followed that trio and are now part of the claim. "They all tell the same story," Goldenberg said. "They feel cheated. You are talking about an unprecedented loss after five months for this kind of high-profile IPO. Hype drove it, and that is fine. But you can't do that on the basis of incomplete information. They feel it is another example of the citizen being taken advantage of by these banks and big corporations."

Where money has been lost on such a scale, conspiracies abound, but two key reasons for the freefall of the stock price, which quickly lost half of its value, seem to have existed in plain sight. The first was the timing of an announcement by General Motors, which the day before the IPO made the decision to pull all advertising from Facebook, suggesting that, having looked hard at its numbers, it had no clear evidence that advertising on the site was effective. The second, perhaps more fundamental, explanation for the market's pessimism lay in the rhetoric of Mark Zuckerberg.

Zuckerberg had never been convinced he should take his company public, though regulatory changes made it inevitable. He worried about shareholders who wanted Facebook's first thought to be its bottom line rather than its product. And he feared a loss of control. To this end, he had created two classes of shares, which guaranteed that he would have 57% voting control of Facebook with only a 28% financial stake. His anxieties were realised almost immediately.

Zuckerberg was used to updating users of his site, but not so practised at reassuring investors. Before the IPO he affirmed what he repeated at the moment of the sale: that he did not see himself primarily as a man in charge of a multibillion-dollar business but rather as a man on a mission to teach the world to poke in perfect harmony. Fundholders are not traditionally seduced by missionaries.

Over the summer Zuckerberg was strangely silent, as if adjusting to his new realities: married life and problems at the office. He had perhaps the first premonitions of what all prodigies discover: that he, too, would have to grow up. In his first call with major investors at the end of July, he pursued a line about the Facebook model that "the best type of advertising is a message from a friend". This had sounded reasonable enough when he had uttered it to interviewers and journalists over the years, and it seemed to chime with popular psychology about tipping points – but was it really true? And if so, where did it leave companies like General Motors, which were spending a small fortune on creating consistent messages about their products that were measurable in terms of sales?

Over the few years since its inception, Facebook had been somewhat cavalier about its revenue strategies, making the seductive argument that once it had a critical mass of users, money would surely follow. Google had solved the intractable problem of how to monetise its audience by having advertisers bid for keywords, selling sponsored links and charging for each time a user clicked on them. Facebook's advertising model was always more intangible, based largely on precisely targeted display adverts and the vaunted "engagement" of the user, who typically spends an hour a day on the site. In a widely quoted figure, Google made $88 from each of its users, Facebook only $15. Moreover, Google's model worked potentially equally well on mobile formats as on desktops. Facebook had been slow to see the shift to mobile, and that apparent anxiety over releasing user data which angered the likes of Hyms, Goldberg and Garrison suggested they were still troubled by the problem of how to make effective use of display advertising on a screen no bigger than a playing card.

Zuckerberg's first public appearance was on a technology platform in September – he talked 10 to the dozen for 20 minutes about the new realities of his business. His message had changed somewhat in the months since the YouTube clip. There was a little less emphasis on the incontrovertible value of pursuing an open and connected world and a little more on the prospect of specific plans for generating increased advertising revenue from "monetising eyeballs". Zuckerberg admitted the company's previous strategy for mobile (he pronounced the word to rhyme with "no bull") had been wrong. But without too many specifics, he was confident Facebook could eventually make more money per user on mobile phones than on desktops. He was also in the bizarre position, having lately made a good many of his staff wealthy beyond reason, of having to face questions about office morale and employee retention. He talked soberly of incentive packages and share schemes, and hoped that his people would stay with him: "It is not the first up and down we have had."

One of the things Facebook has added to the culture in the few years of its existence has been a redefinition of some of the most common elements of our language. It has, according to the Oxford English Dictionary, changed our understanding of the words "like" and "friend", not to mention "poke". It is, Zuckerberg hinted, about to tamper with the dictionary entry for "want" in the same way. Users will be able to have the product they want at the click of a mouse.

The shifting of linguistic usage extends pointedly to the purpose of the company itself. As David Kirkpatrick, Facebook's authorised biographer, notes, one characteristic of the first eight years was a tendency for Zuckerberg and his inner circle to sit around late at night and try to establish exactly what business they were in. These reported conversations are remarkable, in a way, for their lack of clarity. Early on Zuckerberg liked to refer to his creation as "a directory of people" in these discussions (arguably not the most marketable of propositions); Sean Parker, the maverick first president of the company, used to suggest Facebook was "a device you carried around and pointed at people and it would tell you all about them". Later Zuckerberg resolved that it was a product "to help people understand the world around them".

If that was its higher purpose, however, the business Facebook has been in from the start is disclosure. Its products are its users and their friends, who willingly supply personal data about themselves and their habits and tastes on a scale previously unimaginable. Its clients are corporations which can exploit that information to understand an individual's desires and to sell them things based on that knowledge. Facebook's data bank can in this way do empirically what Don Draper of Mad Men did instinctively – it will reveal its users' moment-by-moment wants, conscious and subconscious, and attempt to satisfy them.

Zuckerberg's genius has been to find a way to not only track and store all of that data but also to make it accountable to an identifiable individual, all in the process of "sharing". Facebook rightly makes great capital of its uniquely "granular" privacy tools while whispering all the time about the liberating virtues of total transparency and openness. In this it shares a philosophy with its great rival, Google. As Sergey Brin, Google co-founder, once observed of the implicit contract of internet usage: "If you have something you don't want anyone to know, maybe you shouldn't be doing it in the first place."

Given that its product is its community, you would have thought that Facebook's announcement earlier this month that it had signed up its one-billionth user might have sparked a rally in its share price. In fact that announcement produced not a blip in the markets, which maintained stubbornly that Facebook was worth less than half what it had been on 18 May. To celebrate the remarkable statistic that one in six people on the planet was now a Facebook user, Zuckerberg noted on his home page another new definition of what his company had become. "We belong to a rich tradition of people making things that bring us together," he wrote. "We honour the humanity of the people we serve. We honour the everyday things people have always made to bring us together: chairs, doorbells, airplanes, bridges, games."

This curious list, which sounded like it had been conceived after one too many hackathons, re-emerged a few days later as Facebook's first-ever piece of brand advertising. A commercial to be released in 13 key territories visualised Zuckerberg's extended simile: Facebook was like a chair, because people connect with each other when they sit together. That kind of thing.

On message boards and blog posts the advert also appeared to suggest a quality that Facebook had never previously communicated and which is arguably the last thing an advert really needs: desperation. The ad was the work of Wieden + Kennedy, which is credited with the "Just do it" branding for Nike, but you can't help feeling its sentiment was Zuckerberg's own. The CEO likes to talk in mantras, and the one he has been repeating for a few years now is the apparently neat idea that "Facebook is a utility". This then was his somewhat clunky attempt to show that Facebook's "place on earth" was now a fixture; it is literally part of the furniture.

Is that true? Certainly for millions of its avid and addicted updaters it may sometimes seem that Facebook has become as fundamental to their lives as electricity. Existence without Facebook may be social suicide in those quarters, but could it really be said to have become a necessity? Zuckerberg, seldom shy of ambition, is placing his faith in the idea that it is, or that one day soon it will be. The share price depends on it. He wants us to believe his company will be not one communication platform among many, but will pretty much make up a global network itself. Zuckerberg has, until very recently, an enviable track record of being right in such hunches. And undoubtedly there is an argument that given both its reach and its financial muscle Facebook is here for good and that things can only get better. It may still be that the YouTube clip will be played to future generations in history lessons as the moment when the means by which they most naturally engaged was first formally valued by the world – and that after a summer of discontent its growth never let up. Or it may just look like the best of times for the social network, and that nothing of the future was ever quite so sunny.

Contributor

Tim Adams

The GuardianTramp

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