Bubblewatch

News today that HP is asserting Autonomy had dodgy finances - FT articles the travails:

The struggling US technology conglomerate has alleged that “serious” accounting improprieties at the British software company were responsible for more than $5bn of the writedown.

Meg Whitman, chief executive, said that information provided by a member of Autonomy’s management team after Mike Lynch, its founder and former chief executive, was fired in May had prompted an internal investigation. This revealed improprieties, “disclosure failures and outright misrepresentations at Autonomy”, which occurred before the acquisition.

Whether there was dodgy dealing or not, all you need to know about the Autonomy/HP Brouhaha is contained in these 2 paragraphs from Jonathan Weil at Bloomberg:

HP said in its 2011 annual report that it paid $11 billion for Autonomy, a software company based in Cambridge, England. In connection with the acquisition, HP initially recorded $6.6 billion of goodwill and $4.6 billion of other intangible assets. HP later revised the goodwill to $6.9 billion and reduced other intangibles by about $300 million, according to its most recent quarterly report.

The goodwill figure is especially telling. Goodwill is the bookkeeping entry that a company records when it pays a premium to buy another company. More precisely, it’s the difference between the purchase price and the fair market value of the acquired company’s net assets. Goodwill can’t be sold by itself. The goodwill in this instance tells you that HP paid $6.9 billion more than it believed Autonomy’s net assets were worth.

When you are valuing your $11 bilion purchase at 2/3 Goodwill and your market cap is only c $28bn, you have not just overpaid, you have overpaid ludicrously on a big bet, and it will really hurt if things go wrong...I didn't write about this deal at the time, I saw it as yet another typical Bubbletime deal, and I felt I'd been writing a continual litany on large desperate corporates overpaying for less-than-meets-the-eye-but very-cool small companies (that they believe they can add value to, despite all the historical evidence) for the past year or so.

It would appear that all the HP Board bar one were in situ at the time. Be interesting to see which heads roll.....

With Candide, Voltaire trook several hundred pages to satirise the silliness of unthinking optimism. Gillian Tett took a few hundred words in the FT. She was a young and enthusiastic Euro-optimist, her father was a grizzled Euro-cynic. Here is her apology:

...what is also clear is that my father was entirely correct to be cynical in the face of my optimism. So the question I keep asking myself today is, why did so many people (like me) get swept along by the hype – while others (like my Dad) did not? Why was his cynicism a minority view, in a sea of hope?

One easy explanation, perhaps, might be our relative ages. By the time we had our argument in Val d’Isère, my father was 58 and had lived through numerous economic cycles. I had only worked as an economic journalist for a few years. I had never stared a recession deep enough in the face to become truly wary, rather like those young mortgage traders who stoked up the subprime boom a decade ago.

Then there was the nature of my father’s career. Although he was a brilliant student of economics in the US and UK, he did not go to work in the City or on Wall Street; instead, he headed for the distinctly unglamorous world of British manufacturing, working mostly in midsized companies. So instead of worrying about complex financial products or public policy rhetoric, my father has spent his life thinking about making widgets, such as fire detection equipment.

In that earthy world, there is little place for punditry or wishful thinking: either your sums (and widgets) add up, or they do not. Stock rooms cannot be conjured up by rhetoric alone. Little wonder, then, that my father considered it madness to run a single monetary policy without free labour flows or fiscal union. If the eurozone was a business plan, in his eyes it simply did not add up.

There was also a more subtle factor. Precisely because my father worked in the (then relatively unfashionable) manufacturing world, he was less subsumed by fashionable policy group-think. By 1996, as the financier George Soros says (quoting the psychoanalyst David Tuckett), the euro had become a “fantastic object”: it was unreal but immensely attractive. Or to put it another way, political idealism had subsumed economic gravity. My father, outside the intellectual echo chamber of the eurozone elite, was never infected by the hype.

This sort of explains my complaint from 2006/7, when it was plain that there was a huge problem coming, and nary a peep from the Financial journalism community. I thought they were in the pocket of the Financial industry (as the regulators were), but being mainly "teenage scribblers" (as an earlier Chancellor asserted) who had never seen anything like it is alao a reasonable analysis. But teh real question is "what are the lessons" to avoid unwarranted optimism?

So what are the lessons? One is that it shows the value of retaining older people – or at least, a diversity of life experience – in the workforce. If nothing else, a range of ages helps guard against group-think. Another moral is that it shows the value of having some people from “real” businesses sitting in the corridors of power: handling widgets or running small companies is a good reality check. But perhaps the biggest lesson of all, which journalists, financiers and politicians should all have posted up on their desks, is how wrong we can sometimes be, especially when we are excited by a “cause”.

These lessons are as valid for Technology as Finance, of course - which is why I wrote about it. So if I may abstract, here are...

The 5 Lessons to Guard Against Irrational Optimism.

Run for the hills if:

1. If the issue is a "cause" with a "belief system" rather than based on any hard data
2. If the believers are all young and idealistic, and saying "this time it will be different"
3. If Old Fogeys who have been there before start to get sceptical about it
4. If the numbers don't add up without "heroic" assumptions, and requires everything to go right at all times
5. If the people calling for the New New Thing have never run a business in their lives.

Otherwise, your only hope is to pray "Apres Moi le Deluge"

In late 1999 you couldn't move in San Fancisco's South of Market St area (SoMA) without tripping over a dot-commer. By late 2001 you couldn't move without tripping over derelict cardboard boxes and winos (I was there both times....). Now the Bubbletime seems to be in full swing again - San Francisco magazine:

In spite of the obvious urban warts, the word is out: San Francisco is the world’s leading tech paradise. At a rate eclipsing the dot-com boom of the 1990s, tech companies are setting up shop in the city by the hundreds, drawn by its beauty and livability, as well as the deep pool of engineering talent here and, yes, city hall’s increasingly tech-oriented policies.

Young entrepreneurs from as far away as Denmark, Singapore, and France can be seen with real estate agents in tow, roaming through converted South of Market lofts still vacant from when the previous bubble burst more than a decade ago. The city is currently home to more than 1,700 tech firms, which employ 44,000 workers, up a whopping 30 percent from just two years ago. And San Francisco has been the nation’s top magnet for venture capital funding for three years in a row. Consequently, the distinction between Silicon Valley and San Francisco has all but disappeared. It is us, and we are it.

I'm sure I could probably find the same breathless-yet-anxious prose in Red Herring or similar in 1999. Now there is probably a long term restructuring going on, as for a variety of reasons the Smart Young Things are gravitating to cities rather than campus complexes, but not this fast. Next will come the sky high rentals and deteriorating services for families moving in*. Those who cannot remember the past etc....

(*Hint. Property prices collapse as well as rise....)

100 days on, and Facebook share price has crashed c 40% from its IPO, It joins Zynga and Groupon in a downward plunge (see sheet above).

Nowadays of course everyone knew it was overvalued, but beforehands many were saying it was a snip at its IPO valuation. We were one of the few who didn't and were called "analyst heroes" because of it. But, as Henry Blodgett points out, all you pretty much needed to do was read the prospectus, and Mark Zuckerberg's letter, and it was easy to figure out.:

Didn't anyone even read Facebook's IPO prospectus? The answer, I can only assume, is "no." Because if anyone had read the Facebook IPO prospectus, they would have learned, among other things, the following:

Facebook's growth rate was decelerating rapidly.
Facebook's user-base was rapidly transitioning to mobile devices, which produce much less revenue.
Facebook's operating profit margin was already an astounding 50%, which suggested it had nowhere to go but down.
Facebook's CEO had a nearly unprecedented amount of control over the company.
Facebook's CEO had set up this astounding level of control intentionally. Mark Zuckerberg knew all about how impatient public-market shareholders are. And he set up the whole company so he would never have to pay attention to their whining.
In the 9 months following the IPO, insiders would be free to sell more than 2 billion shares of Facebook that they had been holding for years.
Facebook was going public at an astoundingly high price for a company with these characteristics—about 60-times the following year's projected earnings, in a market in which other hot tech companies like Apple and Google were trading at less than 15-times.

I agree, most of what you needed to know was right there, it wasn't rocket science - but of course, in the Bubbletime the only way is up!

Which makes me wonder what all those analysts who were forecasting $100m valuations and up were doing, exactly. Or, whether the reforms since 2001, that were supposed to make analysts independent, have worked at all?

News today that NASDAQ is going to compensate traders for its system glitches during the Facebook IPO to the tune of $40m (Sharecast via Yahoo):

LONDON (ShareCast) - Nasdaq OMX Group has decided to return 40 million dollars to those brokers whose orders were mishandled in Facebook's initial public offering (IPO) due to technical errors. Specifically, the US stock exchange operator said it will pay $13.7m in cash and the remaining amount would be credited via lower trading fees for those brokers that were affected. A series of glitches when Facebook went public delayed the start of trade by half an hour and left many trades unexecuted.

The traders are still not happy though. But, given the drastic reduction in the Facebook share price (down 30% in a flat market over the period), and the Great Social Media Selloff overall (see chart above), you'd think that these pension funds etc would offer to pay NASDAQ in gratitude, for preventing them from buying even more of a tanking stock at even dumber prices.

Just when we were despairing that the Social Media bubble had fully deflated, thanks to Facebook, we find it may just have moved, to Crowdsourcing - Liz Gannes:

Kickstarter may be the best-known brand in crowdfunding, but Indiegogo now has the biggest war chest. In a new round announced today, Indiegogo now has the backing of Insight Venture Partners and Khosla Ventures. Along with previous investors, the firms provided $15 million in Series A funding for Indiegogo, adding to $1.5 million raised last year. (Kickstarter raised $10 million in 2011.)

Unlike Kickstarter, Indiegogo is open to all projects, is available worldwide, and allows users to keep funding even if they don’t meet their goals (with a 5 percent additional fee). The site had earlier focused on fundraising for film projects, but is now open to any creative, cause-related or entrepreneurial idea.

The platform hasn’t had any crazy breakout hits like the $10 million Pebble watch, but it recently helped raised $325,000 for a film project called “Angry Video Game Nerd,” which was a new record. Indiegogo says it distributes millions of dollars a month.

The site levies a 4% fee for successful campaigns, for campaigns that fail to raise their target amount, users have the option of either refunding all money to their contributors at no charge or keeping all money raised but with a 9% fee. Assuming an average 5% fee, and say that it has 33% net margins ongoing, that means that just to get the $16.5m investment cash back assumes that it has to make nearly $1bn in total turnover, in the VC exit timescale of say c 5 years. No pressure there then*.....

That, and the low barriers to entry (think Incubator 2.0) plus (we will bet) other VC or offset-funded "me toos" coming in with lower fee % rakes, will make this an "interesting" sector going forward. To the winner the (increasing returns) spoils clearly, but what will the margins look like longer term?

Incidentally, take a look at this excellent satire on the current Bubbleicious Social IPO craze - Ponzify.com. Truly the "undertaking of great advantage; but nobody to know what it is" 2.0

*I agree that a breakeven analysis is not the best way to value a startup, but it is always a decent sanity check as to "what you have to believe"....

Facebook went below $30 today, on its way to a 25% price drop from float price amidst lawsuits, disgruntled investors etc etc. But we are more interested in what this has done to the whole Social Media bubble we have been watching.

By re-pricing and increasing the number of shares floated to grab every penny that was ever going to be on the table, and then having such a fiasco of an IPO, it may be that Facebook has burst the whole Social Media bubble. Just as all boats rise in an incoming tide, all sink in the great sucking sound of a rapidly retreating one - Zynga et al have all fallen far farther, far faster than Facebook.

But, of far more selfish interest to us is the future of the Broadstuff Bubble-O-meter. Right now it looks like Facebook has also closed the market for future IPOs. In the beginning of May the Social Media space was hyped to the nines. At its height we saw stories of retail investors (aka "suckers") throwing 40-K, School Fee money and various other essential savings into the gamble (Bubble-O-Meter stage 9), but then - instead of a pop and a frothy rush to Stage 10 and a horde of wannabeee SocMed IPOs behind it, there was a slow hissing sound of a bursting bubble, and by end May the Bubble-O-Meter lies spent on the floor, like the previous nights' rubber johnny, leaving a stain of a high watermark that came - and went - in a matter of minutes. One thing is for certain, the bubble ain't going to re-inflate for quite a while (I'd bet a lot on not in 2012, and probably not 12 months) no mattre how hard the Silicon Valley PR machine huffs and puffs.

And so, we are left with large questions - Will Facebook do a Bubble-O-Meter Stage 10 and buy an Old Media darling with a $16 billion war chest? Or how far back has the Bubble-o-Meter fallen? Or maybe both are true, if Facebook took all the loot on the Social Meedja table so there ain't no more for anyone else? In either case, how long will it take to re-inflate the Social Media bubble? Will it ever inflate again - is this it? Will the Silicon Valley economy collapse again? How many of the Silicon Valley Cheerleader blogs will survive? What Phoenix 3.0's will emerge from the ashes? Has Facebook smartly engineered a Big Bubble Bang behind it to ensure no one can follow it out the gate? How much more can we flog the Bubble-o-meter now that the horse has bolted?

At least we can predict the floor for the stock - with $16bn in the kitty, we calculate Facebook shares are worth at least $6!

Postscript - last Friday I gave a talk on the role of hype in bubble formation - as Facebook was IPO'ng - and noted that once the hype peaks and the slide into the Slough of Despond starts, it is a quick fall for a long way, and an irreversible one at that. Lets see if Facebook follows form.

With this IPO, even an an old cynic like me eventually thinks "nah, now that could never happen, surely" - it does. SEC enquiries, Class action law suits....Reuters:

Facebook Inc and lead underwriter Morgan Stanley were sued by shareholders who claimed they hid the social networking company's weakened growth forecasts ahead of its $16 billion initial public offering.

......

The lawsuit claimed that the defendants, including Facebook Chief Executive Mark Zuckerberg, Goldman Sachs Group Inc and JPMorgan Chase & Co, concealed "a severe and pronounced reduction" in revenue growth forecasts resulting from greater use of Facebook's app or website through mobile devices.

It also accused Facebook of telling its bank underwriters to "materially lower" their forecasts for the company. The lawsuit said the underwriters disclosed the lowered forecasts to "preferred" investors only, instead of all investors.

......

On Tuesday, law firm Glancy Binkow & Goldberg said it filed its own Facebook lawsuit in California state court on behalf of an investor.

Nasdaq OMX Group Inc was also sued on Tuesday by an investor who claimed the exchange operator was negligent in handling orders for Facebook shares. Morgan Stanley said it is reviewing Facebook trades and would adjust prices for some retail customers who overpaid.

........

Regulators including the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and Massachusetts Secretary of the Commonwealth William Galvin are looking into how the IPO was handled. The U.S. Senate Banking Committee is also reviewing the matter.

........


Citing people with direct knowledge of the matter, Reuters this week reported that Facebook during its IPO road show advised analysts for its underwriters to reduce their profit and revenue forecasts.

It also said underwriters Morgan Stanley, Goldman Sachs, JPMorgan and Bank of America Corp cut their forecasts after the May 9 prospectus was filed but that these cuts were not publicly revealed before the IPO.

"If Facebook faced a known and particularly salient risk, boilerplate language would be insufficient," said Elizabeth Nowicki, an associate professor at Tulane University Law School and a former SEC lawyer. "If Facebook told underwriters to lower their forecasts, it would certainly be material."

Bank of America and Barclays Plc are also defendants in the New York case, as are Facebook Chief Financial Officer David Ebersman and several Facebook directors.

My reaction to this was twofold:

Firstly, that there was a lot of very good independent comment out there saying the same thing, so investors who lost their shirts have only themselves to blame.

Secondly, reflecting on my time in the DotCom era, to wonder what - despite all the supposed "improvements" in banking systems in the last decade - has actually changed. Same drivers, same behaviours, same activities, same old same old.

And now there are even people saying the "NASDAQ Glitch" may have been engineered. Right now, I can believe anything.....

Update - US Congressional Committee tolook at IPO - Reuters:

The U.S. House and Senate committees that oversee financial sector matters are planning to look into the issues surrounding Facebook Inc's initial public offering, aides to both committees said on Wednesday.

Sean Oblack, a spokesman to the Senate Banking Committee, said the review will focus on "issues raised in the news" and that staff will be conducting briefings with "Facebook, regulators and other stakeholders."

Watching the stock fall, and the fall out from the Facebook IPO Fiasco has been very entertaining, in that never have I seen so many vested (or would that be invested) interests hoisted on such sky high petards:

1. The "IPO was wonderful" lobby were shut up after Monday morning trading. If it looks like a Turkey.... (In fact now we are seeing the opposite, as everyone lines up to say they knew it was all way overpriced all along. Did they hell, we felt positively alone saying that before the last few days )

2.The Investment Banks told their favoured customers that they were cutting the forward forecast after the latest data - besides being unheard of, these people had 7 days to act, so they really have no excuses.

3. Those IB clients who were not told are apparently Very Upset - but methinks they protest toomuch - for such supposedly smart and in the groove people, it beggars belief they were unable to do the maths themselves when the news of the changes toshares and price was made public - even reading a few knowledgeable blogs (like this one ) and newspapers would have told them that there was a bad moon on the rise.

4. No, I suspect they still thought they could still flip their shares to the Greater Fools out there, but the NASDAQ glitches meant they couldnt - so for once the dumb money was saved from its own stupidity. Hooray for NASDAQ , for once our pensions have not been sucker punched.

5. And now there is a desperate scramble to get NASDAQ to make up their losses, and it would appear the under-writing banks can't even short the stock to wash their faces

And now the Regulator is getting interested in that selective disclosure....:

Reuters reported that Morgan Stanley selectively disclosed the change in Facebook estimates, which drew the attention of the main regulator of U.S. brokerages.

"That's a matter of regulatory concern to us and I'm sure to the SEC," said Richard Ketchum, the Financial Industry Regulatory Authority's chairman and chief executive. "And without saying whether it's us or the SEC, we will collectively be focusing on it.

I think times are about to get interesting... this is just the end of the beginning.

Actually, I rather admire Facebook in a perverse way - they used others' predictable greed to rake every penny that anyone was ever going to put on the table into their own trousers, into the biggest war chest ever. They won't need to tap the markets again for ages - probably just as well, the banks won't be laughing.

Still, if you look at the whole Facebook Story of their culture and ethos from Day One, why would one be surprised

The Facebook IPO really has also been a Tale of 2 Cities - or rather, one city and the Rest Of World. Lets face it, an IPO of this level of hype that sputters, which still forces the under-writers to step in and buy the shares to keep it at the out-the -gate share price, is a Fail. Yet I see many of the Valleyblogs are still faithfully drinking the Kool Aid, while most everyone else is more sanguine - Techmeme records the roster of Kool Aid drinkers and Uh-Oh sayers:

Everything is Rosy through the Kool Aid Lens

John Paczkowski / AllThingsD: - The Price Is Right: Facebook Closes Near Opening Price
Dan Primack / Fortune: 38 Special: Facebook bankers got it right
Erin Griffith / PandoDaily: No Pop Equals a Flop? Welcome to the Irrational World of Public Markets, Facebook
Don Dodge: - Facebook did a great job with the IPO. 500M shares traded and it closed at $38, where it opened. Fairly priced, optimized proceeds to FB.
Lizette Chapman / Venture Capital Dispatch: Greylock's David Sze: Facebook Has Three Things Great Companies Need
Amit Chowdhry / Pulse2 Technology and Social Media News: Mark Zuckberg: “Our Mission Isn't To Be a Public Company”

Uh Oh

Larry Dignan / CNET: - How Facebook's bankers saved an IPO, kept shares above $38
Kim-Mai Cutler / TechCrunch: - Bankers Got Too Aggressive With Pricing Facebook As They Struggled To Keep Shares Above $38
Wall Street Journal: - Facebook's IPO Sputters
Business Insider - Facebook holds the IPO price after war of $38
Michael Hiltzik / Los Angeles Times: Facebook's epic fail
Los Angeles Times: Facebook IPO falls short of the hype
Reuters: Overhyped? Facebook shares stumble on debut

As you can see (with the interesting exceptions of Forbes & TechCrunch), you can define who says what pretty much by closeness to the Facebook epicentre

Incidentally, quite a few of the stories say "observers expected the shares to rise" - I want to know who those observers were, and what they had been drinking over the last few days! They were clearly not reading the newspapers, blogs or financial magazines outside the Kool Aid bubble! (see Tale of 2 Cities - Part 1)

Longer term, pricng it this high really puts the future Facebook under pressure. I think Brent Hoberman's piece in the Guardian said it best - Facebook was "priced for perfection" - meaning they would have to execute perfectly from now on:

The night we went public and raised £120m, Martha and I were very subdued. It felt as if we had the weight of the world, and our employees, on our shoulders, and that the company was priced for perfection. That was massive pressure. However, now I look at Zuckerberg and see someone who really does have the weight of the world on his shoulders, is only 28, and doesn't have a proper business partner.

I had hoped Facebook would resist the temptation that we also felt, to raise the price too much. In our case I'm not sure the added pressure was worth it, and in theirs they really don't need the extra money. I suspect Zuckerberg will feel that pressure, that his world is surreal. But he will be happy that he has been given this chance to continue to change the world – and follow his passion. And that his creation's future is assured for some time to come.

Update - another SV Pangloss-over on TC on Sunday, my favourite line:

According to the pundits, what really matters is that the stock price didn’t increase in value–or “pop”–post IPO and is being propped up by banks.

Actually, what the (indpendent and knowledgeable) pundits were really noting that what mattered was the underwriting banks were having to come in big time to support the price. Monday should be very interesting....