Facebook Going Public – Learning Objective:

• To learn what an IPO is and why a company goes ‘public’

There seemed a time in the business news not too long ago where all you would hear about was the debut of Facebook in the stock market.  Now that Facebook has officially started trading and media outlets have squeezed as much as they can out of its initial stumble, it appears that the world has predictably moved on.  For those beginner investors who were drawn in to the hype of Facebook going public, trying to put the events of Facebook’s debut as a publicly traded company into some kind of context is difficult, especially if the headlines on it have started to disappear. In this second part of our series, we take a closer look at what an IPO means and why they happen.  If you missed the first part of the series, you can click here to read it.

Will that be cash or credit?

To understand how stock markets function, one of the most important questions to ask is how companies end up there. After all, isn’t shopping much easier when you realize why you’re in the mall in the first place?

 

From startups to blue chips, the one rule of business is true – it takes money to make money, and if you’ve got big dreams as a business you’ve certainly got to be able pay for what will help get you there.  Even though some of the regulations have changed, the principle of raising money to grow is as true today as it has ever been – check out this neat little cartoon from the 1950’s for a fun explanation.

The decision that all businesses have to make is how they are going to pay for what they need in order to do what they do.   Of course since money doesn’t just appear out of thin air (unless you’re a central banker – which is another story altogether) it needs to come from somewhere or someone. The two main ways of raising money (that it doesn’t already have)  for a business are to take out a loan (debt) or sell a portion (equity) of your company.

An IPO or initial public offering, similar to the one that Facebook undertook, is an opportunity to raise money to help pay for all of those things that are going to make a company even more money in the future (or at least that’s how the story is supposed to go).  If you are a business owner, you want to raise as much money as possible for your business and “going public” enables businesses to sell shares of their company to the general public, as opposed to selling to only a limited number of investors. Business owners raise money from investors – people who want their investment capital to appreciate in value.

So what’s in it for me?

If you are an investor, what you get in exchange for giving your capital to a company is a portion of that company and any of the future earnings it makes.  The more money the company you invest in makes (and keeps) the more your shares should be worth. Investing in an IPO like Facebook is particularly difficult because nobody is really sure they (Facebook) can make (and keep) as much money as the stock price would suggest.

For the moment there’s a lot of uncertainty and a great deal of expectation – and that is “normal” for many companies that become publicly traded. It is also a very volatile combination. What the dot-com bubble showed us in the late 1990’s is that expectations can skew stock prices, but ultimately whether a company can make (and keep) its money will be the most important test for deep-pocketed investors.  The Facebook IPO also showed us that despite all the hype, its opening price of $42+ was perhaps too high too soon for the overall market to be willing to pay.  What something is worth is really only knowable by what a market for that thing is willing to pay for it.

Cash burning a hole in your pocket?

For Facebook the company though, the ‘middle-man’ (a company called Morgan Stanley) that helped fetch them that high IPO price did a good job of getting as much money as they possibly could for their shares (Morgan Stanley and other underwriters made about $100 million from bringing Facebook public).  Facebook owner Mark Zuckerberg must have definitely made it a point to “like” Morgan Stanley’s Facebook page for helping Facebook the company become a $100 billion (its worth less at the writing of this article) company.  With its hefty war chest, Facebook can spend what it thinks it needs in order to fulfill its lofty business vision. Of course, whether or not they spend it wisely is an entirely different matter.

To read the last article in the Facebook IP-Uh-Oh series, click here.

Some more interesting links about the Facebook IPO are provided below:

• 21 Gems of Facebook’s S-1 That Will Boggle Your Mind
• Facebook IPO stream on the Wall St. Journal

And here is a quick definition of an IPO from Investopedia.