Business Insider: Henry Blodget

PAGING MARK ZUCKERBERG! People Want To Hear From You... (FB)

Henry Blodget — Wed, 30 May 2012 17:15:00 -0400

Facebook's (FB) first couple of weeks as a public company, most observers agree, have been a disaster.

There was the first-day NASDAQ (IXIC) trading scandal, in which many people who bought Facebook stock didn't know whether or not they owned it.

There was a selective disclosure scandal, in which Facebook and its underwriters told big investors that Facebook was having a weak second quarter but didn't tell small investors.

And, of course, there is the stock price.

Facebook's stock is now down about 25% from its IPO price of 10 days ago.

That's an extraordinary decline for a company this large. And with the stock still trading at about 45X next year's consensus EPS estimate of $0.65, the shares are arguably still expensive and could therefore fall further.

Meanwhile, Facebook CEO Mark Zuckerberg is...

On his honeymoon in Europe!

The world hasn't heard a peep from Mr. Zuckerberg since Facebook went public. He got married the weekend following the IPO, and then he jetted off to Europe. And now, with his company being buffeted by criticism from all sides, people are wondering why Zuckerberg hasn't made some sort of public statement.

Rob Cox, Americas Editor for Reuters Breakingviews, thinks Zuckerberg needs to come forward.

Yes, he'll be legally constrained in what he can say, and he'll have to be very careful. But Cox feels that, having played such a small role in the IPO, Zuckerberg needs to take full responsibility for what has happened and let Facebook's shareholders, users, and employees know that he is firmly in charge.

Meanwhile, Zuckerberg himself is feeling his investors' pain.

Bloomberg gleefully announced this morning that Facebook's plummeting stock has caused Zuckerberg to drop off Bloomberg's list of the world's 40 richest people. Zuckerberg is only worth $15 billion now, Bloomberg notes--a far cry from the $19 billion he was worth on the day of the IPO.

Should Zuckerberg come forward and say something?

Or should Facebook's investors, users, and employees just suck it up and sit tight? After all, Zuckerberg couldn't have been clearer in his "letter to potential shareholders" that he was focused on the long-term. And a sharp price decline over 10 days is hardly long-term.

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Okay, Here's How To Fix The Ridiculous Rules That Enabled The Facebook IPO Scandal...

Henry Blodget — Wed, 30 May 2012 07:57:00 -0400

A veteran journalist tells me that now it's not just Morgan Stanley who is blaming me for the Facebook IPO selective-disclosure scandal--it's Facebook, too.

Not officially, of course!

Just on background, when folks ask how it could possibly have been fair for Facebook and Morgan Stanley to tell big institutional investors that Facebook was having a lousy quarter but not share this information with smaller individual investors.

As I explained last week. Facebook and Morgan Stanley are saying that the rules governing analyst involvement in IPOs made them do this. And then they note that these rules were the rules created after the research-banking scandal of the 1990s, in which analysts worked closely with bankers on IPOs.

I was one of the analysts keelhauled for that banking-research arrangement, which, for what it's worth, pre-dated my Wall Street employment by more than a decade.

They keelhauled me, along with a dozen other firms and other analysts, and then they changed the rules.

And so now I'm being blamed for flaws in the new rules--the ones that Facebook and Morgan Stanley say caused them to keep small investors in the dark about Facebook's crappy quarter.

And the rules are indeed ridiculous and unfair.

The rules apparently allow companies going public to give earnings "guidance" to underwriter analysts and then allow those underwriter analysts (and salespeople) to verbally relay this guidance to their big institutional clients. But the rules apparently prevent analysts and salespeople from putting anything in writing or whispering anything to individual clients. And Morgan Stanley says that's why it didn't tell its individual clients about Facebook's quarter.

That's absurd.

Here's how to fix the situation:

Allow analysts to publish full research on companies before they go public, as in the UK, and make this research available to everyone. OR
Remove analysts entirely from the IPO process. Don't let them talk to the IPO company or big clients, don't let them produce earnings estimates, don't let them do anything until the company is public. Then let them write research like everyone else.

Either of those solutions would be fair.

The current system, meanwhile--the one that led to the Facebook selective disclosure disaster--is grossly unfair.

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And They're Lining Up To Buy The Samsung Galaxy S3 In Europe...

Henry Blodget — Wed, 30 May 2012 06:50:00 -0400

Via Philip Elmer-Dewitt at Apple 2.0, here's a video of a (short) line outside a Samsung store in London about an hour before the Galaxy S3 was to be released.

The global smartphone game is a two-horse race between Apple and Samsung right now.

And it's nice to see that a company other than Apple can make products that inspire people to go wait in line.

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Phew! Here's Some Good News For Those Who Are Terrified About The "Facebook Phone"... (FB)

Henry Blodget — Wed, 30 May 2012 05:31:00 -0400

Last weekend, the New York Times reported that Facebook was staffing up with ex-Apple engineers to start making smartphones.

This sounded like a godawful idea.

Investors had the same reaction, pounding the stock down another 10% on Tuesday.

But here's some good news...

Some comments Apple CEO Tim Cook made at the All Things D conference last night suggest--to me, anyway--that Facebook may not actually have to build smartphones, after all.

Specifically, in response to a question about why Twitter is integrated with Apple's iOS operating system and Facebook isn't, Tim Cook said the following:

"I think our relationship [with Facebook] is good. I think we can do more with them. Stay tuned."

"We want to provide customers a simple way to do what they want to do. Facebook has millions of customers. We want them to have the best experience on our platform."

Steve Jobs once referred to Facebook's requirements for integration as "onerous." But Cook seemed to be more open to the idea:

"They have their way of doing things. But people say that about us. It doesn't mean you can't work with them."

Now let's read between those lines and then think about what this means.

All of Cook's comments suggest that Facebook and Apple are working on integrating Facebook into iOS. (What else could they do together?)
There is no way that Apple would integrate Facebook into iOS if Facebook were about to go into the smartphone business and compete with Apple.
Facebook can get what it wants out of smartphones by being integrated into iOS (and other platforms).

So, now let's reinterpret last weekend's news.

Maybe Facebook has been working on a dual-track process, whereby it keeps negotiating with Apple but also holds out the possibility of going into the smartphone business itself. Maybe Facebook has finally now decided to work with Apple instead of competing against it. (Because it certainly can't do both.)

Okay, that's reading a lot into those remarks. But that was the impression I got.

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Here's Another Concern For Facebook Investors--"Payments" Growth May Suddenly Flatten (FB)

Henry Blodget — Wed, 30 May 2012 04:49:00 -0400

This is wonky, but it might be interesting for those who are trying to figure out how much revenue Facebook can generate over the next couple of years.

Facebook's revenue comes from two sources:

Ads
Payments

Ads comprise the majority of Facebook's revenue--82% in Q1.

But Payments revenue is growing much faster than Ads: 98% in Q1, versus only 37% for ads.

Analysts expect Payments revenue growth to keep charging along. A couple of early analyst models I've looked at project Payments growth of ~75% this year, which would nearly double the size of the business to $1 billion.

But that might be tough.

Here's why:

Part of the strong growth of Payments revenue has come from the requirement that all of Facebook's games partners start using Facebook Payments on July 1 last year. That requirement presumably contributed to the rapid growth of Payments revenue over the last three quarters. It will soon anniversary.
Payments revenue declined sequentially in Q1 after rising sharply in Q1 last year--so the decline wasn't the result of seasonality. This suggests that the organic growth drivers of Payments revenue may be flattening. See numbers below.
Zynga accounts for almost all of Facebook's payments revenue, and Zynga's stock is cratering. Falling stock prices often indicate weakness in the business.

I played around with a rudimentary model (below) and came up with a 2012 Payments growth rate that is about half of that projected by the early Wall Street estimates that I looked at.

If Payments growth slows sharply, this won't clobber Facebook's growth for the year--the Payments revenue stream is still relatively small. But Ad growth is slowing rapidly, and 30% growth by the end of the year (as projected below) may end up being a stretch.

For context, when Facebook told its underwriter analysts to cut their estimates two weeks ago, just before the IPO, the new 2012 revenue estimate the company was aiming for was $4.8 billion. The model above puts the company just north of that, at $4.9 billion.

Here's a link to the spreadsheet, if you want to look at it in more detail.

It includes 4 sections:

My aggressive 5-year earnings estimates
My "likely" 5-year earnings estimates
Wall Street's current estimates (provided by the company)
Quarterly breakdown of revenue through 2012

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What Are The Sources Of Anti-Semitism?

Henry Blodget — Tue, 29 May 2012 12:25:00 -0400

WRITER'S NOTE: This post engendered a lot of empassioned responses. Some of the responses were directed at the question I posed; Others were directed at me.

I normally don't shy away from passionate responses: In fact, I feel that part of my job is to write about topics people care about enough to respond passionately to. And when I saw the response to the British test question I described below--the same question I posed here--I thought that this would be a question our readers might want to respond to as well.

(I had actually been thinking of asking this question for a while. A couple of weeks ago, I wrote an article about Goldman Sachs that led to the arrival of some of the anti-Semitic commenters who seem to be prevalent online. As I was deleting their comments, I thought, as I had before, "Where on earth does this stuff come from?")

As I said, the post was greeted with an empassioned response. Lots of the feedback, believe it or not, was positive: I was praised for starting a discussion on a sensitive topic. But lots of the response was also negative--as in, "What kind of an insensitive rockhead would ever ask a question like that?"

Some readers also felt that, if I was going to ask why some people hate Jews, I should also ask why some people hate blacks, Mormons, Christians, Muslims, and every other group that is occasionally subjected to hate. And I certainly could have asked those questions, too (If the commenters on my Goldman post and the British religious-studies exam had focused on Muslims, I might have asked that question first). One smart reader suggested that I just summarize all those questions by asking "Why do people hate?" And that was a reasonable question.

And then I got the feedback that clued me into the fact that I had crossed a line I hadn't intended to cross. Some people I like and respect told me they felt insulted by and uncomfortable with the post.

That did it.

Whatever interesting responses came from the post, I now regret writing it. (I'm okay making people feel uncomfortable about some topics, but not this one.)

I am very sorry to anyone I offended. I sincerely apologize.

ORIGINAL POST:

Citizens in Britain were startled recently when a religious-studies exam featured the question, "why do some people hate Jews?"

The question was immediately blasted as inappropriate and quickly withdrawn.

But it's an interesting and important question.

Along with many other sites, this site is occasionally visited by people whose mission in life appears to be to express hatred of Jews. (We delete these comments as quickly as we can, but they're always startling in their venom, meanness, and stupidity.)

And hatred of Jews has obviously been an ongoing theme worldwide for centuries.

Hitler, for example, hated the Jews so much that he murdered 6 million people.

Why?

What is the source of this animosity? Why does it perpetuate itself? Where did this prejudice come from?

I'm asking this question seriously, and I'm going to Bleacher any comments that don't answer it seriously. As usual, I'm also going to ban any anti-Semitic commenters. And I'm only going to keep the comments open for 24 hours, because I know what will happen once I stop checking back in and reading them.

In the meantime, I'm genuinely mystified and curious, and I look forward to reading your responses.

Why do some people hate Jews?

Or, put in a more delicate fashion, what are the sources of the anti-Semitism that seem to play such a central role in many people's lives?

NOTE: The original photo in this post was of a couple of jovial Orthodox Jews, one of whom was wearing a traditional hat. Some readers found that needlessly provocative. One suggested I replace it with a picture of Natalie Portman. So I have.

NOTE 2: The original title of this post was "Why Do People Hate Jews?" That made a lot of people angry. Folks seem more comfortable with the current title, which, admittedly, is less direct. So I changed it.

UPDATE: Now I see why Britain was startled when this question appeared on that religious-studies exam. Apparently, it's not a question you're supposed to ask.

UPDATE 2: Readers would also now like me to ask the following questions:

Why do people hate ____ people [fill in any skin color]
Why do people hate ____ [fill in any religion]
"Why do people hate?"

Those are all good questions, too. Feel free to add your answers to those below, too.

UPDATE 3: John Podhoretz has been kind enough to send along a list of books on this topic, written by professor Robert Wistrich. It's available here. Please let me know which is the best, and I'll read it and summarize it in a future post.

NOTE 4: Thank you. Lots of interesting comments mixed in with some more predictable ones (along with a lot of frustration with me for even posing the question). I'm going to close the comments now, because I can't keep scanning them. I'll read Mr. Podhoretz's book recommendation above and come back with the scholarly answers.

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DEAR JOURNALISM STUDENTS: Don't Mean To Intrude, But Your Professor Doesn't Get It

Henry Blodget — Tue, 29 May 2012 09:42:00 -0400

We had a good laugh in the (virtual) newsroom this weekend when folks started passing around this letter-to-students from a journalism professor at the University of Tampa.

The professor, who describes himself as a "college journalism scholar," advised his students not to admire the success of our Deputy Editor Joe Weisenthal, who was named the best business journalist of 2011 and was recently profiled by the New York Times.

Why doesn't the professor think his students should admire Joe Weisenthal?

As best I can tell from his letter, the professor thinks:

Joe Weisenthal works too hard
Joe Weisenthal goes to the bathroom too much
Joe Weisenthal publishes too many posts each day
Joe Weisenthal, in his role as real-time commentator, occasionally expresses opinions that turn out to be wrong [welcome to market commentary, professor!]
Joe Weisenthal works for a publication whose only concern is informing and entertaining its digital readers, instead of writing magazine articles that college journalism scholars approve of

Instead of admiring Joe Weisenthal, the professor says, his students should admire Anthony Shadid, the amazing New York Times print journalist who recently died while on assignment in Syria.

And there, at least, the professor has some good advice for his students: Anthony Shadid was indeed amazing. If the professor's students think the print version of the New York Times will be around long enough for them to become international print-journalism war correspondents for it--and they want to become international print-journalism war correspondents for the print version of the New York Times--they should absolutely learn from Anthony Shadid. He was one of the best.

If the professor's students want to work in a newer medium, however, one that is gradually becoming the primary medium that the world's people gather their news and information from, the students would do well to have more respect for Joe Weisenthal's skill than their professor does.

Because in this new medium, Joe Weisenthal is also one of the best.

A few points on this:

Yes, it's true: There's nothing that fuels success like hard work, passion, talent, and a will to win. The professor seems appalled that Joe Weisenthal loves to work so much. Perhaps that's because, in the past couple of decades of print journalism, life had been so good that print journalists got used to not having to work much. Perhaps that's because, for the professor, work is "work" (unpleasant toiling). Or perhaps that's because the professor has tenure. In any event, it's true that Joe Weisenthal's dedication, intensity, and passion for what he does are part of what makes him so popular with our readers. He cares passionately about whatever story he's covering--so passionately that he wants to stay on top of it. Our readers love that.
Storytelling in the digital medium is very different than storytelling in print or broadcast. In a world in which millions of sources of information are a click away, having a talented journalist monitor and filter and add smart context to that global information fire hose in real time is extremely valuable to readers. Basically, this medium is a hybrid of broadcast and print: That's why Joe Weisenthal and other talented digital writers write fast and speak conversationally (TV news hosts do the same thing--they just do it on camera). If the professor worked in a profession in which news mattered, he might have more appreciation for that.
The skills required to do what a great real-time digital journalist does are different than those required to do what a great magazine writer does. That's not a knock against magazines--magazines are great. But it's why most magazine writers fail miserably when they try to write for this medium: Because they're good at writing magazine articles, not at telling stories using the full capabilities of the digital medium, including covering unfolding stories in real-time, using text, pictures, video, and commentary.
Doing what Joe Weisenthal does is extraordinarily difficult. That's why there are so few Joe Weisenthals. I'm just guessing here, but I'd bet that if we put the good professor in Joe Weisenthal's chair, he would fail miserably. Why? Because he would try to write magazine articles, which most online readers get enough of in magazines.

Basically, like a lot of critics about digital journalism, the professor seems to regard the "Long Magazine Article" as the highest and best form of journalism, to which all budding journalists should aspire.

And that's fine. Great long magazine articles are great, and hopefully some people will keep writing them.

But holding the "Long Magazine Article" up as the highest and best form of journalism is to impugn other forms of journalism that require just as much talent and effort to produce and, in many cases, have far wider readership and far more promising future employment prospects than long magazine journalism.

For example:

TV. One suspects the professor also does not admire TV reporters. This is also typical of many snobby print folks, who dismiss TV journalists as "talking heads." Well, let's at least acknowledge that those talking heads are viewed by vastly more people than print journalists--and are therefore much more influential. And let's acknowledge that they make a lot more money than print journalists. Also, any print journalist who thinks it's easy to be a compelling talking head should take a look at the awful "video news shows" produced by the Wall Street Journal, New York Times, and other prestigious print news outlets. Making good TV is difficult. Print folks don't know how to do it.
Digital. Successful digital news outlets, ourselves included, are hiring and training as many talented digital journalists as we can. These folks all have a couple of key attributes:

They come in open-minded, willing to experiment and learn the best ways to tell stories in this medium, not in other media.

They're multi-talented, combining the following skills: Writing, editing, news judgement, storytelling, photography, videography, intensity, creativity, passion, and speed.

It's also important to note, because the professor didn't, that Joe Weisenthal's style of digital journalism is only one part of what has made Business Insider and other thriving digital news outlets so successful.

In our newsroom, which now numbers about 50 very talented people, we also have folks who are extremely skilled at disciplines that the professor might find more familiar and admirable, such as investigative journalism, photography, videography, technology and feature production. Our investigative pieces and features look different than similar stories in magazines, of course, because--again--this medium is different, but they're longer than some of our real-time news posts. And the professor seems to admire length.

In hopes that the professor might want to share these, too, with his students, here are a few we would recommend to him:

The bottom line: We're eager to hire as many talented digital journalists as we can (not TV or print journalists--digital journalists). The way we view it is that digital journalism is in the same place as TV journalism was in the 1940s and 1950s--loved by viewers, exciting and innovative for journalists, growing extraordinarily rapidly and therefore offering young journalists enormous opportunity, and sniffed at by The Establishment.

So, if any of the professors' students have any of the attributes described above and are eager to work in the medium of the future instead of the media of the past, we'd love to hear from you.

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Summer's Coming, So I Want To Tell The Story About How My Husband Drowned At The Beach

Henry Blodget — Mon, 28 May 2012 10:05:00 -0400

Everyone who swims in the surf has a scare at one point or another.

The current grabs you and pulls you out to sea.

Instead of going with it, you fight it.

Soon you're exhausted.

In January, a husband and wife from New York were swimming together in the Caribbean when this happened. The wife, Maria Beaulieu, made it out of the water. Her husband of 24 years, John McWhinnie, didn't.

In the East Hampton Star this week, Beaulieu told the story to Russell Drum.

Summer's coming, she said, and people are headed to the beaches to swim. So she wanted to describe what had happened.

Jan. 6, 2012, was a Friday. The couple were vacationing on Virgin Gorda. They packed a light lunch and hiked 45 minutes from their hotel to get to a more secluded beach. “We got there about 10 a.m. The tide was high, the surf very big. I was in shock. I had never seen it like that. It was a gorgeous day, big white puffy clouds. I was stunned at the size of the waves — but beautiful.”

The couple took several cooling dips during the day. The snorkeling was compromised by sand and silt kicked up by the surf. “On one of the last times, he looked at me and said, ‘You don’t like it.’ I said, ‘I like it a click less.’ That’s what we used to say, ‘a click more or a click less.’ ”

“I don’t like being slammed. I grew up on lakes. I love it when the ocean is like a lake, a beautiful gentle ride. That’s why I loved to go down to the Caribbean. The movement is so healing, and for us, with no kids, and John’s season is the summer, we’d go when everyone else was coming back.”

Ms. Beaulieu’s eyes stared out her window, focused on a group of chickens feeding in the past. “We only had a nut bar and a couple of apples. Right before the last time we went in, a chicken was looking for food. John being John decided to share his apple. He tossed a piece to the chicken but scared it off.”

“We looked at the water. The tide was out. It looked like we might snorkel. ‘When we leave, the chicken might calm down.’ ”

“John went in ahead of me. I was defogging my mask,” Ms. Beaulieu said, returning to the moment she saw her husband taken by the rip current.

“We were in the water 30 seconds. How did this happen? Nobody was in the water. We didn’t mean to go so far out. What’s going on? He looked at me. I knew it was panic. Then we hit coral. Oh my God, what way do we go? And the waves were hitting us. At one point I pushed him toward the beach. It probably made it worse for him.”

Ms. Beaulieu said she remembered seeing Mr. Chait and his wife watching them from the beach. “I was waving, I knew I needed to do the two-arm wave. I screamed at the top of my lungs. It probably further panicked John. I saw George put his things down. I told John he had to calm down. ‘You’ve got to breathe. Just lean back; pick your feet up.’ He was looking at me for guidance. It was then I heard George say, ‘Go right, go right.’ ”

“I saw him take at least one stroke to the right. Walls of water were hitting me. John was on the other side of the walls. I was exhausted. I think I was out of the current. George was on the sandbar trying to see John. He brought me to the sandbar. I said, ‘He’s panicking. Please go get him.’ I heard a woman scream for me to get out of the water. I knew George knew how to get us out of this mess. I allowed him, put faith in him. I had taken on water, exhausted, given my all, everything I could for John.”

Ms. Beaulieu recalled the agonizing moment she realized she could no longer help her husband. George Chait brought Mr. McWhinnie to shore. “For 45 minutes they worked on him.”

Read the full story by Russell Drum at the East Hampton Star >

A Fulbright scholar and rare book dealer, John McWhinnie lived in East Hampton and New York City.

As his wife Maria concludes at the end of the story, "life turns on a dime."

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Meanwhile, In Europe, The Train Wreck Continues... Spanish Bond Yields Soar

Henry Blodget — Mon, 28 May 2012 09:06:00 -0400

It's a holiday here in the U.S., but in Europe it's business as usual.

Specifically, it's back to the train-wreck.

Spanish bond yields are up sharply, to a staggering 6.5%. Much higher, and Spain's debt load will no longer be sustainable.

And Spain, remember, is a real problem, whereas everyone gave up on Greece years ago.

In case, you're just tuning in to the Europe situation, here's what's going on...

For the past five years, Europe as a whole--and Greece, Spain, Italy, and especially--have been the epitome of a slow-motion train wreck. Although Europe's leaders have managed to find a way to get through a series of successive mini-crises, the situation as a whole continues to get worse.

And this is not surprising. Because the fundamental problem in Europe still hasn't been addressed:

The basic structure of the Eurozone, in which efficient, rich countries like Germany operate with the same currency as inefficient poorer countries like Greece and Spain without the richer countries subsidizing the poorer ones simply won't work.

For the Eurozone to permanently solve its problems, one of two things has to happen:

The Eurozone needs to break up and go back to different currencies, or
The richer countries need to subsidize the poorer ones

For everyone involved, solution 2 would be a better outcome. And maybe Europe will get there. But, for now, that solution still really isn't even on the table.

Meanwhile, the situation in Spain and Italy continues to deteriorate. And it will inevitably lead to more bailouts and debt restructurings, just the way it did in Greece. The only question is when.

Here's a look at the 10-year bond yields of both countries, along with the U.S.:

SPAIN: Bond yields continue to rise...

ITALY: Better, but still headed in the wrong direction.

For context, here's the U.S., which has plenty of financial problems of its own. Bond yields just keep dropping...

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If Facebook Really Goes Into The Mobile Hardware Business, Investors Should Run Away Screaming (FB)

Henry Blodget — Sun, 27 May 2012 21:22:00 -0400

Facebook is poaching ex-Apple engineers to build a smartphone, Nick Bilton of the New York Times reports.

This is the third iteration of Facebook's smartphone plans--from hardware to software and back to hardware again.

If Facebook is serious about jumping into making smartphones with both feet this time, Facebook investors should be very afraid.

Why?

Several reasons:

The move would clearly be defensive, not offensive. According to a Facebook employee quoted by Bilton, "Mark [Zuckerberg] is worried that if he doesn’t create a mobile phone in the near future that Facebook will simply become an app on other mobile platforms." Translation: Facebook is doing this because it thinks it has to, not because it wants to.
Hardware is an extraordinarily difficult, low-margin, commodity business. The only two companies that are doing well right now in hardware are Apple and Samsung. Both have been making and selling hardware for decades. Lots of other companies that have been making and selling hardware for decades are cratering, such as Research In Motion and Nokia. Palm already cratered.
The smartphone "platform" business is already dominated by Apple and Google (Android), and there are already a whole lot of also-rans. Amazon has entered the platform game. Samsung may "fork" Android and enter the platform game. Microsoft is desperate to make its new Windows mobile product matter. RIM still has a piece. And so on. If Facebook really wants to build a brand new mobile platform, it will be starting from miles behind the leaders.
Hardware distribution is critically important, and Facebook also faces vast, entrenched competition there. How is Facebook going to get shelf space at the carriers? By offering super-cheap phones? That won't do wonders for its margins. Is Facebook going to build a network of stores? Is it going to try to circumvent carriers? Google already tried that. Didn't work.
Although Facebook might want to be a mobile platform, there's no obvious need for a Facebook phone. There are already a gazillion phones and Facebook is available on all of them as an app or via a browser. Why would anyone want a dedicated Facebook phone, especially if it didn't run all the apps that run on Apple and Android phones?
A full-fledged hardware business would likely radically reduce Facebook's profit margins. One of the advantages of Facebook's current business is that it is extraordinarily profitable. The hardware business would likely make it a lot less profitable (per dollar of revenue).
Facebook knows absolutely nothing about making, selling, or supporting hardware. Really--nothing. Yes, Facebook could use its billions to buy RIM or Nokia, and then it would know something about hardware. But RIM and Nokia are deeply troubled companies that are already cratering. Can you imagine how difficult it would be to buy, integrate, and FIX RIM or Nokia? (Google's about to give us a case study in how difficult it is with Motorola).

That's just a start.

Perhaps Facebook doesn't really have any intention of building a full-fledged phone--perhaps it just wants to partner with someone like HTC or Samsung. But even then, all the same challenges apply.

Facebook already has an "operating system" for mobile--it's called the social graph.

So instead of building a phone, which seems like a desperate move, Facebook should partner with every operating system and carrier and hardware maker it can to try to embed this social platform within every mobile platform. And it should build great apps to float on top of these systems. (And if Apple keeps giving it the brush-off, it should probably start by cozying up to Samsung, which is the only company giving Apple a run for its money).

Yes, everyone wants to be Apple.

But there's only one Apple right now.

And Facebook's chance of becoming the next Apple seems even smaller than Apple's chance to become Apple was.

The fact that Facebook is even thinking of going into the hardware business is a bad sign. If Facebook actually does go into the hardware business, it will be a really bad sign.

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And Now's The Perfect Time For A Megalomaniac To Make A Big Offer For The New York Times...

Henry Blodget — Sun, 27 May 2012 14:00:00 -0400

The New York Times Company continues to shrink, selling off one asset after another in an attempt to delay the inevitable--a significant restructuring of its flagship newspaper.

The company's digital business is thriving--it's one of the best news sites in the world--but the digital business cannot carry the weight of NYTCO's dying print product forever.

And it was that product, the print product, that once made owning the New York Times not just a major status symbol for the Ochs-Sulzberger family, but an enormous cash cow as well.

Eight years ago, in its heyday, the New York Times Company was worth $7 billion and paid a dividend of more than $100 million a year.

Now, it's worth $1 billion and pays no dividend.

The company still owes more cash than it has--net out cash and debt, and NYTCo's $300 million in the hole--and its pension plan and debt service payments continue to consume a huge amount of the cash its shrinking businesses generate.

In the past three years--recovery years for the economy--the New York Times's free cash flow (the cash left over when all the bills are paid) has shrunk as follows:

2009: $196 million
2010: $113 million
2011: $29 million

At that rate of decline, the company will soon be consuming cash.

Meanwhile, after the firing of the company's CEO last fall, the New York Times Company has no one at the helm. No one, that is, except for Arthur Sulzberger Jr., who is the company's CEO in everything but name--a fact that will continue to make it challenging for NYTCo to hire a talented CEO. Talented CEOs, the kind who might be willing to make the hard decisions necessary to get the company headed in the right direction again, do not like being lackeys. And whoever takes the CEO job will be Arthur Sulzberger's lackey.

Also meanwhile, the many members of the Ochs-Sulzberger family, who collectively still control the New York Times Company, are said to be getting restless about the loss of the fat dividend that funded the lifestyle to which they had become accustomed, as well as the collapse in their equity wealth due to the company's clobbered stock price.

And, by now, it has presumably become obvious to everyone involved, including the Ochs-Sulzberger clan, that there is no magic wand to wave that will miraculously restore the paper's lost glory and the family's lost wealth.

All of which means, as Joe Hagan observes in this excellent New York Magazine article about the sacking of former CEO Janet Robinson, that the time is right for someone to make an aggressive play for the New York Times.

A few years ago, before Rupert Murdoch made his extremely aggressive offer for the newspaper he had coveted for decades, The Wall Street Journal was emphatically not for sale.

Like the Ochs-Suzlbergers, the Bancroft family that controlled Dow Jones considered owning the Wall Street Journal et al as part of their family identity. Thus, when Murdoch made his pre-emptive $5 billion offer for the company, the initial reaction of the Bancroft family was to tell him to get lost.

But then personal self-interest kicked in.

And some members of the Bancroft family began to realize the following:

Nothing is forever
Taking Murdoch's offer would suddenly restore much of the wealth they had lost
Refusing Murdoch's offer would open the family up to years of litigation from other Dow Jones shareholders who viewed the offer as a once-in-a-lifetime ego-fueled bonanza

And, gradually, over the course of a few months, the family's will softened, and Murdoch claimed his prize.

And, although they lost their source of family identity, the Bancroft family, unlike the Ochs-Sulzbergers and other newspaper-dynasty families, got to watch the implosion of the newspaper industry from safe atop humongous mountains of cash. It was the shareholders of News Corp. who took the hit from the collapse in the value of the Wall Street Journal, not the Bancrofts. And the family now looks brilliant for letting go of its dynasty at precisely the right time.

Not so, the Ochs-Sulzbergers.

They've ridden the value of their paper down with the industry.

But an aggressive offer from a dynastically wealthy megalomaniac like Murdoch, for whom the paper's financial future is inconsequential, could, in an instant, fix all that.

Instead of having to preside over several more years of painful shrinking and restructuring, fighting with the paper's various unions, and shoveling cash into the company's bottomless pension plan--all the while being quietly ridiculed by the press, friends, and acquaintances for driving the family's glorious enterprise right into the ground--the Ochs-Sulzbergers could exit, gloriously, stage left. Not at the top--that opportunity is long gone. But at least far from the inevitable bottom.

All it would take would be a nice, fat cash offer from someone for whom money is no object and some assurances of ongoing commitment to journalistic integrity--the latter to make it easier for the family to save face.

And who is ideally equipped to make an offer like that?

As Joe Hagan points out, New York Mayor Michael Bloomberg's name is always near the top of the list.

Bloomberg's company, Bloomberg LLC, is the second most powerful media company in the world (the first is Google).

The company is said to spin off some ~$6 billion or more of cash flow each year, and Michael Bloomberg owns more than 70% of it.

Bloomberg LLC could make a huge, preemptive offer for the New York Times Company with only 4-6 months of cash flow.

And it could then own one of the most prestigious and influential media properties in the world, one that fits nicely in its growing global media empire.

For many reasons that we'll go into later, acquiring dying media properties like the New York Times is a logical step in the evolution of Bloomberg LLC, one that will accelerate the company's goal of becoming an enormous consumer media organization, in addition to a globally ubiquitous professional one. And buying the New York Times Company would be a great place to start.

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Everyone Who Thinks IPO "Pops" Are Good Has Been Brainwashed

Henry Blodget — Sat, 26 May 2012 11:41:00 -0400

Last Friday, after Facebook stock started trading at $42, most observers immediately pronounced the IPO a flop.

Why?

Because the IPO had been priced at $38, which meant that the IPO "pop" was only about 10% above the IPO price.

Facebook stockholders who had bought the IPO the night before had instantly made 10% overnight--a spectacular return. String together a few months of daily returns like that, and you would quickly be one of the most successful investors in history.

But some Facebook speculators had expected to make much more free money overnight--perhaps as much as speculators in LinkedIn and other hot IPOs had made.

So they felt disappointed and ripped off.

And the media, who have been carefully trained by Wall Street and short-term speculators to view IPOs with big pops as "successful" and IPOs with small or no pops as "flops" immediately dissed Facebook as a flop.

Now, there were two serious issues with the Facebook IPO that complicate any discussion focused on this IPO in particular: The NASDAQ screwup that borked at least a day's worth of trading, and the "selective disclosure" scandal, in which the underwriters told their big clients that Facebook's second quarter was weak but did not tell their small clients this.

Both of those issues may well have affected Facebook's first day of trading and contributed to the subsequent price decline. And both of those issues are legitimate sources of frustration, for investors and the company alike. (So please don't bother raising these issues in the comments below: They're separate and apart from the point of this discussion, which is about first-day "pops.")

According to a source very close to the situation, all other issues aside, Facebook was aiming for a 10% pop. Not a 25% pop. Not a 50% pop. A 10% pop. And for most of the first day of trading, that's exactly what Facebook got. In other words, Facebook did exactly what it was hoping to do.

Facebook knew well how this 10% pop would be perceived by the media: As a disappointment.

But Facebook understood what most companies that go public don't:

Any press grumbling about "disappointments" and "small pops" will be quickly forgotten.
The only investors who benefit from "pops" are short-term flippers who won't help the company long term and don't deserve free money
"Pops" cost the company and its existing shareholders hundreds of milions of dollars (in Facebook's case, billions)
"Pops provide no advantage to the company other than a bit of extremely expensive and ephemeral excitement and PR
Pricing the IPO high enough to have only a small pop meant raising millions or billions more dollars that would subsequently be worth milions or billions of dollars to the company

Specifically, in Facebook's case, if Facebook had priced the IPO at, say, $30, instead of $38, it would have raised ~$12.5 billion in the IPO instead of $16 billion.

In exchange for a bigger "pop," happier speculators, and a more enthusiastic press reception, in other words, Facebook and its selling shareholders would have sacrificed $3.5 billion that they can now use to create real value for the company and its shareholders (including its new shareholders).

$3.5 billion is real money.

Blowing $3.5 billion on making speculators and financial reporters happier would have been the height of short-term thinking. And, like other great companies, Facebook doesn't make decisions aimed at creating short-term value. It makes decisions designed to create long-term value.

The extra $3.5 billion Facebook raised by aiming for 10% pop will create at least $3.45 billion more value for Facebook over the long term than a bigger "pop" would have. (The short-term press hyperventilation and speculator euphoria may create some value for a company, but not much. And it may even be harmful to the company by making everything after the IPO seem like an anti-climax.)

But, but, but!

What about the IPO investors?

Shouldn't Facebook and other IPO companies want to make investors happy?

Shouldn't they be less greedy and give investors a reward for taking a chance on them?

Yes.

IPOs should not be priced "at market value." They should be priced just below market value This rewards initial investors for taking the chance on the IPO pricing (which is always risky--no one knows exactly what "market value" will be). And it gives the investors an incentive necessary to do the research on the company before it goes public. Without that, the investors might just wait to see where the stock traded and do the research then.

But any investor who thinks they need more than a 5%-10% overnight return as a reward for placing an order on the IPO is unbelievably greedy.

Again, a 10% return overnight is a spectacular return.

A 10%-20% return, which is what early-stage IPOs should aim for, is an even more spectacular return.

So any investor who thinks they deserve more than that is just greedy.

But What About "Broken IPOs" -- They're Terrible, Right? [No]

What if the "market value" for a company on the first day of trading is higher than a conservative market value that a conservative investor would place on it? What if the stock drops below the IPO price after the first couple days of trading? What if the company has a "broken IPO?"

Yes, what about that.

This is where Wall Street's brainwashing of clients and the media about IPOs has been most insidious and effective.

So, really, what if a company has a "broken IPO?" Isn't that a huge disaster?

No.

In fact, it's hardly worth mentioning.

What it means is that investors who placed orders for the IPO at certain prices and were intending to hold the stock for more than the first day of trading and were unwilling to tolerate a drop below the IPO price were too aggressive in their bids.

That's the investors' fault, not the company's fault. And the resulting disappointment and disgruntlement is called "buyers' remorse." And it happens all the time, in almost every industry and type of transaction on the planet.

Let's use a real-estate analogy.

Let's say a beautiful house is being put up for sale. The agent hired (and paid) to sell the house advertises it everywhere, so all potentially interested buyers know about it. Then the agent calls for bids. The agent explains that there will be only one round of bidding, so bidders need to submit their highest and best offers. Then the agent and the homeowner look at all the bids and pick one, probably the highest. And then the house is sold at that price.

The day after the deal, it is highly unlikely that the buyer would be able to resell the house for the price he or she just paid--because he or she offered the highest bid around. The true "market value" for the house, in other words--the average price paid by most buyers and sellers--might actually be below the price the buyer paid.

The seller of the house, meanwhile, has gotten full market value for the house--just as he or she should.

No one complains that there wasn't a "pop" in the house price.

No one thinks the buyer "got screwed."

No one says the agent should have sold the house at 25% below market value just to give the buyer a "pop."

In fact, if the buyer ever complains that he or she paid too much for the house, everyone will tell the buyer to grow up and look in the mirror if he or she wants to figure out who to blame.

And it's exactly the same for IPOs.

Any "pop" in the stock price on the first day is the difference between the IPO price and the market value.

The market value is not, perhaps, a "conservative value that only a cautious prudent investor would pay," but the market value--the average value that all investors, conservative and aggressive, are paying.

Any investor who chooses to pay market value for an IPO needs to accept that. And if he or she doesn't want to accept that, then he or she just shouldn't place a bid. (This is voluntary stock speculation, after all: We're not talking about selling water and air.)

"But It's Not Like Selling A House... It's Like Selling Apartments!" [No, It Isn't]

There's one more argument that sophisticated "pop" defenders invoke. And that's this:

Selling an IPO is not like selling a house. It's like selling an apartment in a big apartment building with lots of apartments. What you're trying to do with the first sale, the pop defenders say, is generate excitement for the stock, by showing how much money can be made if buyers start speculating on the apartments. If you give away a lot of free money to the first few buyers, this story goes, others will see how much money is being made and then they'll pile in and start buying. And the value of all the apartments will go up!

That argument sounds sophisticated and intelligent, but it's wrong.

Why?

Because the shares in an IPO are sold all at once, not one after the other.

And future sellers of shares in the company--existing shareholders--will not be selling any more shares for months after the deal, at which point the trading price of the stock will be determined by the first day "pop" on the IPO but by what has happened in the interim.

"No!" the IPO pop defenders shout.

"The first-day pop determines everything! Investors who don't get a pop will storm off in disgust, and they'll never come back! The company's stock price will be lower forever, because burned investors will always want to punish the company!"

I hope no one seriously believes this.

The reality is that after a stock settles in the weeks and months after the IPO, what happened on the first day of trading is quickly forgotten. Potential buyers and sellers of the stock react to "news"--to what is happening in the market and industry and at the company--not because of some collective market memory about the IPO price. And, in any event, even in a huge deal like Facebook, the investors who played the IPO are only a tiny fraction of all available investors out there, so even if the investors who didn't get their free-money pop remain disgruntled, plenty of other investors will rush in to fill the gap.

So, if IPOs pops are actually bad, why does everyone think they're so good?

A few reasons:

Everyone loves free money, so when a handful of speculators get lucky and make a lot of it (when an IPO is underpriced), they're very loud in celebrating their brilliance and success
Pops are exciting and controversial! Pops give the press an excuse to write breathless stories about the IPO, in which they can rave about the "instant overnight millionaires and billionaires" and the "popular madness and delusions of crowds" and other age-old stories that sell newspapers and cause viewers to tune in (and get clicks).
Wall Street has brainwashed companies and the media into thinking that pops are good. Why? Because a healthy "pop" makes it easier for Wall Street to keep both kinds of clients happy--not just the issuer (company) client but the investor clients. Wall Street deals with issuer clients only every once in a while, when companies do IPOs or secondary offerings. But Wall Street deals with investor clients every day. So Wall Street loves to dole out favors to those investor clients at the expense of issuer clients. And those favors often come in the form of huge IPO pops.

What a small IPO pop like Facebook's really means is that the underwriter has correctly assessed market value (often hard to do) and then priced the stock just below market value. In other words, they've done a great job for their issuer client and a fine job for their investor clients. Especially on a hot offering, this is extremely hard to do. That's why I said last week that Morgan Stanley had priced Facebook perfectly.

Yes, in the week since its IPO, Facebook has traded down sharply. But a lot of that sell-off is due to the NASDAQ screwup and the now-widespread understanding that Facebook is having a weak second quarter (something that was only known by institutions). And a lot of it is also probably due to the fact that many, many players placed orders for Facebook only because they were hoping to get a huge IPO pop.

These speculators--and that's what they are, speculators--did get a nice modest pop. Again, on the first day of trading, unless they were burned by the NASDAQ screwup, they could have sold their stock for 5%-10% more than they bought it for the day before--a spectacular return. And if this was still disappointing to them, well, then, that's because they were greedy.

Meanwhile, Facebook raised $16 billion at a good price, one that--at the time it priced the stock--was just below the market value.

The extra cash that Facebook raised by pricing its stock 10% below market instead of, say, 25%, will create value for the company for decades to come.

If the company executes well, meanwhile, memories of the "broken IPO" will quickly be forgotten.

And anyone who doesn't believe this should just take a look at Amazon.

Back in 1997, when Amazon went public, the stock quickly "broke" the IPO price.

As it was for much of its early history, Amazon was shellacked in the press for this.

15 years later, Amazon is up about 75X from the IPO price.*

And the shellacking has long since been forgotten.

* No, I don't think Facebook is going to go up 75X from the IPO price. This is in part because Facebook went public at a far more mature stage than Amazon. When Amazon went public, it was valued at $500 million. When Facebook went public, it was valued at $104 billion. It's a lot harder to create oodles of future value from a $104 billion level than it is from a $500 million one.

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You'll Enjoy This Tidbit About How Morgan Stanley Decided Which Clients To Give Facebook Stock To...

Henry Blodget — Fri, 25 May 2012 13:00:00 -0400

Everyone's getting pretty sick of the whole Facebook IPO thing (ourselves included), but here's one more tidbit for you before the holiday weekend...

As you know, there was tremendous demand for Facebook stock prior to Facebook's IPO (and prior to small investors learning what big investors already knew, which was that Facebook had reduced its outlook for the second quarter).

Basically, there was way more demand for Facebook stock than there was shares.

So Morgan Stanley and the other underwriters had to figure out which small clients to give stock to.

You might think that this decision was made by size of account (assets under management), with the bigger clients getting the most stock.

But it wasn't!

At Morgan Stanley, a source reports, this decision was made as follows:

The individual clients who were the most profitable for the firm got the most stock.

In other words, the clients that had paid Morgan Stanley the highest fees in prior years got big allocations.

That's fair. It's not just on Wall Street that the best clients get the best service.

Of course, in this case, the strategy backfired--at least for those clients who didn't flip their Facebook stock on the first day of trading.

Morgan Stanley's best clients, the ones who got the most Facebook stock on the IPO, have now gotten the most hosed.

Whoops!

(By the way, this allocation decision wasn't made by Morgan Stanley's financial advisors, who have gotten reamed in this whole thing. It was made by corporate HQ. The FAs were pissed about it, too.)

[ I would like to confirm information like this with Morgan Stanley before I publish, but they're not responding to my emails or calls. I can't imagine why. ; ) ]

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Now We Know The Clever Spin Morgan Stanley Is Using To Mute Outrage About The Facebook IPO...

Henry Blodget — Fri, 25 May 2012 12:08:00 -0400

As I reported yesterday, Morgan Stanley held a firm-wide conference call last night to address its clients' frustration about the Facebook IPO.

I now know exactly what was said on that call.

As a result, I also know exactly how Morgan Stanley is trying to spin the "selective disclosure" problem, in which Morgan Stanley's big clients got advance word about Facebook's lousy second quarter and Morgan Stanley's individual clients and financial advisors didn't.

On yesterday's call, I am happy to report, Morgan Stanley did not blame me for its decision to share bad news about Facebook with some clients and not others. (On a conference call the prior day, reportedly, the firm did exactly this.)

What the firm did do was engage in some clever spin designed to mute the outrage.

As it has said before publicly, the firm said it followed standard procedures and rules for IPOs. And, this time, it further explained that these rules prohibit its research analysts from publishing research on IPO companies but allow the analysts to talk to the companies, produce and share performance estimates, and talk verbally with clients.

Morgan Stanley did not comment on the absurdity of these rules on yesterday's conference call. But it stated them accurately. (As we've said, the rules are ridiculous and need to be changed).

And, then, on the conference call, Morgan Stanley moved on to its clever spin job.

On May 9th, the firm said, Facebook filed an amended prospectus with the SEC (true).

This amended prospectus, the firm continued, included "the content of the amended guidance." (spin)

In response to this "amended guidance," the firm went on, the firm's research analyst cut his estimates. (almost certainly false).

In other words, the firm strongly implied, the supposedly secret bad news that Morgan Stanley's big clients got was available to all clients in the prospectus...in the form of "amended guidance."

Clever!

This is, of course, the only thing that Morgan Stanley could say. And it gets at the question that the legal fight will likely hinge on.

The truth is that Facebook's IPO prospectus did not contain anything like "amended guidance." In fact, it didn't include any "guidance" at all. All the prospectus included was a vague new sentence on page 57 noting that users were continuing to grow faster than revenue.

Nor is it plausible that Morgan Stanley's research analyst cut his Facebook estimates based on the new language in the prospectus, as the firm suggested on yesterday's conference call.

Rather, Morgan Stanley's research analyst, along with the 20 other analysts who were reportedly called by Facebook and directed to reduce their 2012 revenue estimates from ~$5.1 billion to $4.8 billion, most likely cut his estimates based on the very explicit guidance received on this phone call, rather than on the vague new sentence in the prospectus.

To this former securities analyst, at least, the difference between 1) the new, vague language in the prospectus and 2) being called and told by the company's CFO's office to reduce revenue estimates from one very precise number to another very precise number is night and day.

The former is just a vague and mildly unnerving sentence buried in a prospectus.

The latter is truly "amended guidance." (Or, more accurately, "reduced guidance.")

But it seems Morgan Stanley will take the position that the two were exactly the same thing--and, therefore, that all Facebook investors had access to the same bad news.

They weren't the same thing, of course.

And the difference between the explicit bad news that Morgan Stanley's big clients got and the vague new sentence on page 57 of the prospectus that most of Morgan Stanley's financial advisors and smaller clients got is critically important.

But it's no surprise that Morgan Stanley is spinning them as the same thing. They have to! Otherwise this is a clear and egregious case of selective disclosure.

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By The Way, The Facebook IPO Screwup Could Be Curtains For NASDAQ

Henry Blodget — Fri, 25 May 2012 09:46:00 -0400

It's hard to overstate how big a disaster the Facebook IPO has been for NASDAQ, one of the United States' two big stock exchanges.

People often forget that the NASDAQ and New York Stock Exchange (NYSE) are private companies, just like the companies that list on them. As such, the exchanges compete fiercely for "clients"—which in this case are public companies looking for a place to list their stocks.

15 years ago, in the 1990s, the relative positioning of NASDAQ and New York Stock Exchange were clear:

The New York Stock Exchange (NYSE) was the exchange for big, boring, prestigious industrial companies.

NASDAQ was the exchange for exciting, disruptive technology companies.

Over the past decade, however, the New York Stock Exchange has revitalized itself and begun to make serious inroads into NASDAQ's core franchise: The high-tech, innovative companies that in the 1990s would have automatically listed on NASDAQ.

In recent years, for example, the NYSE has won hot tech companies like LinkedIn and Pandora. NASDAQ has also won its share of tech clients, including Groupon. But now, with each new tech company, it's a fair fight between the exchanges, whereas they once all went to NASDAQ.

The battle for the Facebook listing, not surprisingly, was intense. For NASDAQ, especially, winning was critical, because if NASDAQ had lost Facebook, its positioning as the "home for innovative tech companies" would really have begun to slip.

Ultimately, for reasons that have yet to be disclosed, NASDAQ won.

But what should have been a crowning achievement for the exchange has now become what one tech insider describes as a "complete cosmic catastrophe."

Instead of getting credit for listing Facebook, NASDAQ blew the whole first day of trading. And its reputation in the tech community may have suffered irreparable harm.

It has already been extensively reported that Facebook is considering switching its listing to NYSE, which would be a devastating blow. And a growing group of investment and brokerage firms are coming forward to blame NASDAQ for screwing their clients.

Worse, one tech industry insider furious about NASDAQ's handling of the Facebook IPO tells us that no tech executive who understands what happened with Facebook will ever list on NASDAQ again.

The source doesn't buy NASDAQ's explanation for the problems—that the exchange's systems just glitched for the first half-hour. Rather, the source says, the entire day was a "rolling train wreck."

Perhaps most importantly, the industry insider says that senior tech executives and bankers believe that Facebook's stock collapse after the IPO may have been almost entirely due to the NASDAQ screwup.

Why?

Because the failure of NASDAQ's systems caused enormous confusion about who did and didn't own stock, along with how much they owned and at what price. As these problems continued throughout the day, the source says, many investors just gave up trying to figure out what was happening and retreated to the sidelines. And their disappearance from the market, the insider thinks, exacerbated the stock decline.

Now, we're obviously still in the middle of the Facebook blame game, and as the world moves on, the intensity of the frustration with NASDAQ will presumably fade. And NASDAQ is still the home of Google, Microsoft, Oracle, and other tech giants.

But if NASDAQ wants to win the future tech-industry listings that will be crucial to its maintaining its positioning as the exchange of the future, it is likely going to have to come up with a much more complete explanation for what happened last week—and why it will never happen again.

In the meantime, the advantage in this exchange duopoly has now firmly shifted to the NYSE.

DISCLOSURE: The New York Stock Exchange is a frequent sponsor of Business Insider, and we're thrilled about that. The NYSE has also graciously allowed us to host huge, opulent parties on the floor of the stock exchange, which we're also thrilled about. On the other hand, I've hosted a finance show for Yahoo for the last four years from the NASDAQ in Times Square, and I have a lot of friends there. So I was certainly not happy to see them fall on their face.

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New Details On How Morgan Stanley Is Blaming The Facebook IPO Scandal On Me!

Henry Blodget — Fri, 25 May 2012 08:16:00 -0400

Yesterday, I described how Morgan Stanley was holding firm-wide conference calls to explain the Facebook disclosure scandal to its angry financial advisors and clients...and how, on at least one of those calls, my name had come up repeatedly.

The Facebook disclosure scandal, you will recall, is about how Morgan Stanley and the other IPO underwriters verbally relayed bad news to their big clients about Facebook having a crappy quarter...but didn't tell their financial advisors and individual clients about this.

As a result of this selective disclosure, in the days leading up to the Facebook IPO pricing, institutions had much better information about Facebook's current business than individuals did. And that may be one reason why the stock tanked after the IPO: Because there's nothing like finding out a company is having a lousy quarter to cause people to dump stock.

I also described how it has recently become a convention on Wall Street to blame me for everything. Bank of America blamed me for its cratering stock price last summer. Morgan Stanley is blaming me for the Facebook disclosure scandal. And so on.

(I am relieved to report that JP Morgan hasn't blamed me for its ~$5 billion trading loss yet. I've always thought that Jamie Dimon was a class act!)

Anyway...

The word I got yesterday was that Morgan Stanley was blaming the Facebook scandal on me because I have recently written articles about how outrageous it was that institutions were told about Facebook's lousy quarter and individuals weren't. In other words, because I had hyped up the scandal and gotten Morgan Stanley's clients all hot under the collar about it.

I tried to discuss this with Morgan Stanley yesterday, but their approach to dealing with me right now is to ignore my emails and calls. So I didn't get very far.

Instead, last night, I talked to someone familiar with Morgan Stanley's view of the situation.

And I discovered that the firm really is blaming the whole Facebook IPO disclosure scandal on me...and not just because of the recent articles I've been writing!

Explaining this story will require a lot of background, so grab a cup of coffee and settle in. Otherwise, the short version is this:

Morgan Stanley is saying that the regulations put in place after the research-banking scandal of the 1990s—in which I was Exhibit A—caused this new disclosure scandal.

The Origins Of The Ridiculous Rules That Just Hosed Morgan Stanley Clients

You will unfortunately no doubt recall that, a decade ago, I was a famous Wall Street analyst.

Specifically, I was one of the top-ranked Wall Street Internet analysts during the dotcom bubble. One of the reasons I was famous was that I had been very right about the Internet stocks for 3 or so years in the late 1990s, when some other analysts were wrong. But then, like a lot of other analysts, I made the mistake of trying to perfectly time the bursting of what looked like a bubble—and I waited too long to downgrade the stocks. And then I was disastrously wrong.

That was a searing lesson for me—one I will never forget. I had actually put a lot of money where my mouth was—on a handful of the top Internet stocks—and I lost most of that money. I also missed the chance to save my clients a lot of money by getting them out before the collapse. I will forever regret that.

(In my defense, it really wasn't just me who waited too long. Pretty much everyone waited too long. If you go back and read articles from the summer of 2000, you will find almost every big money manager quoted as saying the recent pullback in the NASDAQ was a fantastic buying opportunity. It wasn't until that fall, after I had downgraded the stocks, that the world ended.)

Anyway, part of every analyst's job in those days was to work with their firms' bankers to take companies public. Analysts were involved in evaluating IPO candidates, pitching IPO candidates, positioning IPOs, marketing IPOs, and then providing research on IPOs after the companies went public. This was a longstanding industry practice, one that had been around since long before I got into the industry. It had also been described frequently in the press: The top analysts were said to have to "wear two hats," banker and analyst, and have to help investors while also maintaining great relationships with companies. At some firms, analysts were even paid directly for banking deals, though that wasn't the case at my firm (Merrill Lynch).

This involvement of analysts in the IPO process, not surprisingly, occasionally created pressure and friction between bankers and analysts, as well as between analysts and companies. The banks made more money from banking than they did from trading, and there were many stories of analysts getting fired after annoying banking clients with negative reports. Companies, meanwhile, gave detailed information to friendly analysts and shut out negative analysts, so if you didn't maintain good relationships with companies, you often were unable to add much value for your investor clients. And this friction only increased as the bull market roared on, because negative analysts were not only annoying—they were also usually wrong.

After the market crashed, a new New York Attorney General named Eliot Spitzer decided to look into the research-banking conflict. And, thanks to my visibility, he started with me. My research team and I had had a penchant for writing really colorful emails to each other—I famously dissed a stock that we were covering that had collapsed as a "piece of junk"—and these emails provided spectacular ammunition. In the spring of 2002, Spitzer alleged that the reason I had been slow to downgrade the dotcom stocks was because of the banking conflict.

That latter conclusion was not, in fact, true. (My firm categorically denied that part of the allegations at the time). The reason I had been slow to downgrade the stocks was that, like thousands of other investors and analysts, I had thought that the bull market had longer to run.

But Spitzer was certainly right that the banking conflict had created friction and stress for us and that we had not wanted to recklessly damage the firm's banking business—or, for that matter, companies' businesses—by recklessly downgrading stocks. (After an 18-year bull market, downgrades were highly unusual).

After extending his investigation to many other firms, Spitzer forced an industry-wide settlement in which the involvement of research analysts in IPOs was pared back and the "Chinese Wall" between research and banking was strengthened.

This industry reform had several consequences, some of which were positive and some of which were negative.

On the positive side, the reforms removed some stress for analysts. Once analysts were no longer evaluated in part on banking business, they focused more on serving institutional investor clients and researching already public companies. And that's unequivocally a good thing.

On the negative side, it became harder for companies to go public...because it turned out that having analysts involved in the screening, positioning, and marketing of deals and then providing follow-on research coverage of small companies made the whole IPO process work better. So that, arguably, was a bad thing.

And that brings us to today...

When the Facebook IPO disclosure scandal was revealed a few days ago, Morgan Stanley immediately protested that it had followed all the rules.

And that may, in fact, be true.

The problem is that, as Facebook has illustrated, the rules themselves are grossly unfair.

The story that Morgan Stanley is telling people is that Spitzer's research reforms actually exacerbated the Facebook IPO disclosure problem, in the following ways.

Before Facebook, the assumption was that every communication from an underwriter's research analyst about an IPO candidate would be positive. Whatever the analyst had to say, in other words, could be construed as "hyping" the stock and making it easier to sell.

In their desire to protect unsophisticated investors from this "hyping" of IPOs, regulators decreed that underwriter research analysts would not be allowed to publish any research on an IPO—or publish anything in print—until a certain amount of time after the deal.

Back in the 1990s, this "quiet period" was 25 days. After the Spitzer reforms, it was lengthened to 40 days.

But, more importantly, the underwriter research analysts were still allowed to do three things to help the firm's big institutional investors:

Talk to company management about the business
Generate estimates for IPO companies with management's help
Discuss these estimates and their opinions verbally with big institutional investors

The idea was that institutional investors would be sophisticated enough to evaluate the analysts' estimates and opinions, instead of just regarding them as "hype" and mindlessly placing orders.

In the view of the regulators, in other words, the institutions did not need to be "protected" from the enthusiasm of research analysts. So they could talk to the analysts and learn all they could from them (which in most cases was a lot). Individual investors, meanwhile, were assumed to be clueless and gullible and therefore in need of protection from analyst enthusiasm.

So now you can begin to see the irony of all this...

Most of the rules in the IPO process are designed to protect individual investors from getting too much good news about companies.

But the important news on the Facebook IPO was bad news.

When Facebook realized it was having a crappy second quarter, it called up the analysts at all the underwriters and told them to cut their estimates. And the analysts did as they were told. And then the analysts and their firms got on the phones with big institutional investors and told these investors about the crappy quarter and estimate cuts.

Meanwhile, the financial advisors and individual clients of the underwriters, who were thought to be in need of protection from good news, not bad news, were kept in the dark. Because that's what the regulators had wanted... to restrict communications from analysts to individual investors on IPOs, on the theory that anything analysts had to say about IPOs would be positive and, therefore, hype-y.

So that's the other way that Morgan Stanley is now blaming me for Facebook IPO disclosure scandal.

The research reforms that Spitzer's settlement brought about restricted the already limited level of communication between analysts and individual investors on IPOs. Because, after the dotcom bubble, it apparently never occurred to anyone that analysts would have anything negative to say.

So, in other words, we've just seen another vicious example of the Law of Unintended Consequences.

So, That's The Problem... What Is The Solution?

So, what's the answer?

Here's the answer:

We need to stop treating individual investors like babies.

We need to stop pretending that it can be smart and safe for individual investors to "play IPOs" and start being forthright about how investing in stocks is speculative and risky and that even expert analysts are often wrong.

We need to start educating the public about how hard it is even for the most well-trained and experienced professionals to consistently make money trading stocks. (Most pros lag index funds.)

And then, we need to make exactly the same information available to individuals as we do to institutions.

In this case, we can do this in one of two ways.

First, we can change our pre-IPO disclosure rules to match those in the UK. The analysts at the underwriters could write full research reports on the pre-IPO companies and then publish them BEFORE the IPO marketing process, thus sharing their insights and estimates with everyone.

If regulators are terrified that this might induce some innocent individual investors to start speculating, we should remind the regulators that the individuals are adults and, as such, should take responsibility for their own decisions.

Alternatively, we should eliminate analyst involvement in the IPO process entirely. No talks with company management, no phone calls with institutional investors, no estimates, no nothing.

Either of these solutions would be better than the current system.

Because, as the Facebook IPO just revealed, the current system is grossly unfair.

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Morgan Stanley Is Holding A Firm-Wide Conference Call To Blame The Facebook IPO Scandal On... Me (!?)

Henry Blodget — Thu, 24 May 2012 15:12:00 -0400

A source close to Morgan Stanley tells me the firm is holding a firm-wide conference call at 4PM New York time today to discuss the firm's role in the burgeoning Facebook IPO scandal.

Another source close to the firm reports that Morgan Stanley has already held at least one such call... and that, during that call, my name came up repeatedly.

I don't yet have detailed information about what was said on the prior call, but the gist of it, apparently, was this:

Morgan Stanley followed all the applicable rules and regulations in the Facebook IPO
Henry Blodget is a disgraced former-analyst-sleazebag-turned-bloviator who is just trying to whip up a scandal out of nothing.

(I assume they didn't put it quite that way. At least I hope they didn't! I have friends at Morgan Stanley!)

A couple of points on this...

First, it now seems to be becoming convention on Wall Street to blame me for everything. Last summer, Bank of America—which now owns one of my former Wall Street employers, Merrill Lynch—blamed me for its cratering stock price. And now Morgan Stanley appears to be blaming me for its decision to give bad news about Facebook's business to some of its clients and not others.

Why is Wall Street always blaming me?

I don't know. I assume because I'm an easy target.

(I wish I weren't, but unfortunately getting accused by Attorney General Eliot Spitzer of swindling people will do that to you. It has now been almost a decade since Mr. Spitzer keelhauled me over conflicts of interest between analysts and bankers on tech IPOs. As I've said often over that decade, I'm grateful to every one of the millions of people who have given me the chance to earn back their trust. If that group of people includes you, thank you. I am truly grateful. If it doesn't yet, maybe someday...)

(By the way, Eliot Spitzer and I are actually sort of becoming friends now. Life can be pretty surreal sometimes. Anyway, Eliot was kind enough to invite me on his show the other night. When I told him about this latest egregious Wall Street shafting of individual investors, he was apoplectic. All I can say is that Morgan Stanley had better count its blessings that he's not still Attorney General!)

Second, if Morgan Stanley's defense to its employees and clients on the Facebook IPO is the same one it issued publicly—that it followed all rules and regulations—it is missing the point.

Morgan Stanley gave bad news about Facebook to its institutional clients.

Morgan Stanley did not give this bad news about Facebook to its thousands of financial advisors and hundreds of thousands (millions?) of individual clients.

Morgan Stanley can say until it is blue in the face that it followed the letter of the rules and regulations.

What it cannot do is say that it was fair to share bad news about Facebook with some of its clients and not others.

In other words, Morgan Stanley cannot look any employee or client in the eyes and say that it followed the spirit of the rules and regulations about selective disclosure. Because it obviously didn't.

The spirit of the rules and regulations is that all clients have equal access to the same important information.

The fact that a company, Facebook, suddenly reduced its business outlook just days before its IPO is highly important information.

Morgan Stanley knew this information, which it got directly from Facebook. (Facebook called Morgan Stanley's analyst and other analysts and told them to cut their performance estimates.)

Morgan Stanley then shared this information, verbally, with major institutional clients.

Meanwhile, Morgan Stanley said nothing to its thousands of financial advisors and hundreds of thousands of individual clients.

Then, when it came time to price Facebook's IPO, Morgan Stanley allocated a much-larger-than-usual percentage of the offering to the individual clients—the ones who had been kept in the dark about the bad news.

Later, when those individuals and others found out about the bad news, Facebook's stock tanked.

And now Facebook's stock is trading at the same level—~$32—that Morgan Stanley's well-informed institutional clients were reportedly willing to pay for it. And it is trading well below the level that Morgan Stanley's uninformed individual clients were willing to pay.

Importantly, I highly doubt that anyone at Morgan Stanley intended to do anything wrong here. The density of true sleazebags on Wall Street is no greater than it is in any other industry, and the vast majority of people on Wall Street are good, hard-working professionals who are trying to do a good, honest job. I assume everyone at Morgan Stanley, therefore, was just trying to help their clients and follow the rules.

(Though I do think it's reasonable to have hoped that someone at the firm would have stood up and said, "Wait a minute—this is unfair." There is no information more material than a sudden change in business outlook at a company. And the fact that senior people at Morgan Stanley stood by and watched as this information was shared with some clients and not others is disappointing.)

Nor do I think Morgan Stanley is the only entity that should bear responsibility here. All the other firms in the IPO syndicate did the same thing. And I also think Facebook bears some responsibility: It should have clearly disclosed in its prospectus that its revenue growth had suddenly slowed and that, as a result, it was reducing its outlook for the year. Instead, Facebook merely inserted vague language about how users were continuing to grow faster than revenue.

But the end result at Morgan Stanley was that a handful of big clients received critical bad news about Facebook, and the rest of the firm's employees and clients didn't.

Some of Morgan Stanley's individual clients are reportedly furious about this. And so, reportedly, are some of its financial advisors.

I sympathize with them. If I were a Morgan Stanley client or financial advisor, I'd be furious, too. Because what happened is just grossly unfair.

When Eliot Spitzer went after Wall Street in 2002, he was told by my firm and others that the firms were just following the rules in place at the time. That was true. We were following the rules. But from Eliot Spitzer's perspective, that was not a reasonable defense. The rules that we were following, Spitzer said, created big conflicts of interest—an observation that I certainly agreed with. And in the wake of Spitzer's allegations, the rules governing the interaction between bankers and analysts were changed.

And now, a decade later, we find ourselves in the same situation.

Whatever rules Morgan Stanley is saying it followed when it decided to share bad news about Facebook with some clients and not others are grossly unfair rules.

And those rules need to be changed.

(Morgan Stanley did not respond to an email in which I offered to discuss this.)

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And Now More Details About How Big Facebook Investors Got Inside Info—And Little Guys Got Hosed

Henry Blodget — Thu, 24 May 2012 06:52:00 -0400

Earlier this week, we described how big potential investors in the Facebook IPO got important negative information that small investors didn't get:

Namely, they got a heads-up that Facebook's business had suddenly deteriorated.

This "tip" came in the form of sudden estimate cuts by the research analysts at Facebook's IPO underwriters, who were told by company management that the second quarter was falling short of expectations.

This information was then shared verbally with big institutional clients of the underwriters, but it was not published anywhere or shared with small investors or the public.

In other words, Facebook basically pre-announced disappointing second quarter results, but this information was only shared with a handful of the investors who were considering investing in the IPO.

Perhaps partly as a result of this selective disclosure, we also reported that small investors placed bids for Facebook stock at much higher prices than institutional investors who knew about the business slowdown. The scuttlebutt (unconfirmed) was that institutions were willing to pay $32 for Facebook, while small investors, who did not know about the business slowdown, were willing to pay $40.

The IPO was priced at $38, and a big percentage of the stock—25%, reportedly—was sold to small investors. For a day, everything went fine: Anyone who bought the IPO could have flipped it for a nice gain. But then, as many investors dumped shares and news of the business slowdown spread, the stock collapsed. It is now trading at $32, the price that well-informed institutions were said to be willing to pay for it.

Regulators will now look into whether Facebook's public disclosures and the underwriters' behavior broke any laws.

But irrespective of legality, obviously, this selective disclosure of critical information was grossly unfair.

Every investor on the planet deserved to know about Facebook's sudden business slowdown. And the fact that only a select group of institutional investors heard about it—verbally—is outrageous.

We have also explained that the "estimates" that the underwriter analysts suddenly cut in the middle of Facebook's roadshow weren't really estimates at all. Rather, they were more like company guidance—an unofficial outlook for the business shared with the analysts by Facebook management. It is standard practice for underwriter analysts to work closely to develop estimates that the company has "blessed." And these estimates are then used to market the IPO.

But, absurdly, these estimates are not shared with all investors. They're only shared with big investors. Which means that, even on a normal IPO, big investors have critical information that small investors don't.

On the Facebook IPO, because Facebook took the highly unusual step of changing its guidance in the middle of the roadshow, this unfairness became extreme.

Gina Chon, Anupreeta Das, and Aaron Luchetti of the Wall Street Journal have now reported more details about how news of Facebook's business slowdown was shared with big investors and not little ones:

Three days into the roadshow, Facebook filed an updated prospectus with the SEC. As we have noted, this document contained vague language about how Facebook's users were continuing to grow faster than revenue, but it did not say anything about sudden second-quarter revenue weakness.
Immediately after the filing, a Facebook executive called the analysts at 21 Wall Street firms and told them to cut their estimates. According to one person we talked to, this message was very explicit.
As can be clearly seen in the new estimates published by four of Facebook's biggest underwriters, this new performance guidance was not at all vague: All of the major underwriters cut their revenue estimates for 2012 from ~$5.1 billion to ~$4.8 billion. There is no way that the "estimates" would be this close without crystal clear guidance from the company.
Meanwhile, the institutional sales forces at the underwriters fired up the phones and called their big clients to tell them about the estimate cut and revenue slowdown.
Not surprisingly, this news was taken as a significant negative by the investors, and many of them soon reduced their orders for Facebook stock or reduced the price they were willing to pay for it.
Some of these investors, including the powerful Capital Research Group, also found the later price increase for the Facebook IPO "ridiculous," especially in light of the estimate cut. Some Capital Group funds did not buy the IPO at all.

The fact that 1) Facebook called 21 underwriter analysts and told them to cut their estimates and 2) the firms of these analysts then verbally passed on this information to their biggest clients should eliminate any question about what happened here.

This was selective disclosure of critical non-public information.

Facebook's amended prospectus did not say that the company's business had suddenly weakened and management's outlook had changed. And that information is vastly more important than what the prospectus did say, which was that users are growing faster than revenue.

These new details should also make Facebook investors who didn't know about the estimate cut even more furious.

Wall Street and Facebook will presumably argue that they followed "all applicable rules," as Morgan Stanley said two days ago. If that is true—and, this should certainly be carefully investigated—the rules are obviously ridiculous. And they should immediately be changed.

Also, whether the letter of the rules may have been followed, the spirit of the rules clearly was not.

A company suddenly reducing its business outlook is highly material information. Every potential Facebook investor should have been immediately and clearly informed of that. And it would be laughable to suggest otherwise.

So, once again, big Wall Street insiders got privileged information. And little investors got the shaft.

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TO BE CLEAR: The Facebook Estimates That Analysts Cut Were More Like Company Guidance Than "Estimates"

Henry Blodget — Wed, 23 May 2012 12:59:00 -0400

A lot of people still don't understand why the Facebook bombshell that broke yesterday--that analysts had cut estimates during the roadshow--is such a big deal.

Analysts change estimates all the time, they point out. And they're just estimates. So who cares?

Well, the first point is that only big investors got these estimates, not all investors. So there's a problem right there.

But another reason it's a big deal is that these particular estimates aren't really estimates, at least not in the true sense of the word.

Rather, they are "estimates" that are developed through close collaboration between the analysts at the IPO underwriters and the management of the company that is going public.

In other words, they are really a form of guidance--the company's outlook about how its business is expected to perform.

That's why the estimates of all of Facebook's underwriters were all so close to one another. And that's why, when the Facebook analysts all suddenly cut estimates a week into Facebook's IPO roadshow, the new estimates were also so close to one another.

Don't believe it? Let's look at the revenue "estimates" from the top four Facebook underwriters for the full-year 2012--estimates that were never released to all Facebook investors (uncovered by Reuters):

Morgan Stanley -- $4.854 bln (new estimate) from $5.036 bln (old estimate)

Bank of America -- $4.815 bln (new estimate) from $5.040 bln (old estimate)

JP Morgan -- $4.839 bln (new estimate) from $5.044 bln (old estimate)

Goldman Sachs -- $4.852 bln (new estimate) from $5.169 bln (old estimate)

The full-year revenue estimates are all within a few tens of millions of one another (less than 1% deviation).

Think that happened by chance?

Of course not.

Think it happened because the analysts read the amended prospectus, as Morgan Stanley suggested in the statement it released yesterday?

Of course not. The prospectus didn't say anything about the second quarter being weaker than Facebook had expected. And it certainly didn't say anything about how Facebook's new guidance for 2012 was now ~$4.8 billion of revenue, instead of the ~$5.1 billion of a couple of weeks earlier.

What almost certainly happened here was that the underwriter analysts worked with company management to come up with reasonable estimates before the IPO marketing began. And then, a week later, when Facebook realized that its second quarter was going to be weaker than it expected, Facebook called the analysts and told them to cut their estimates. And not only did Facebook tell the analysts to cut their estimates--it almost certainly told them what to cut the estimates to.

In other words, again, these estimates aren't really "estimates." They're guidance.

Basically, Facebook gave unofficial earnings guidance to the underwriter analysts. And, a week later, when Facebook realized its business was weak, it reduced this guidance.

That's why these estimates were so meaningful to the institutional investors who got them during the roadshow: Because they reflected direct and timely guidance from the company about how the quarter was progressing.

And that's why the fact that these estimates were only distributed to a handful of big investors, instead of to all investors, is so grossly unfair.

Now, it may be that delivering guidance like this through the underwriter analysts is perfectly legal and in keeping with all rules and regulations, as Morgan Stanley also said. But that doesn't mean it wasn't also grossly unfair to investors who weren't privy to the "estimates."

If a company you were thinking of investing in suddenly cut its guidance (outlook), you would want to know that.

And if you didn't know that, and other investors did, you'd be angry.

And you'd have every right to be angry.

Because this would be yet another case in which Wall Street insiders knew what was really going on, and you were kept in the dark.

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EXCLUSIVE: Here's The Inside Story Of What Happened On The Facebook IPO

Henry Blodget — Tue, 22 May 2012 17:30:00 -0400

And now for some more bombshell news about the Facebook IPO...

Earlier, we reported that the analysts at Facebook's IPO underwriters had cut their estimates for the company in the middle of the IPO roadshow, a highly unusual and negative event.

What we didn't know was why.

Now we know.

The analysts cut their estimates because a Facebook executive who knew the business was weak told them to.

Put differently, the company basically pre-announced that its second quarter would fall short of analysts' estimates. But it only told the underwriter analysts about this.

The information about the estimate cut was then verbally conveyed to sophisticated institutional investors who were considering buying Facebook stock, but not to smaller investors.

The estimate cut appears to have influenced the investment decisions of at least some institutional investors, dampening their appetite for Facebook stock, and crucially, affecting the price at which they were willing to buy Facebook stock.

As I described earlier, at best, this "selective disclosure" of the estimate cut is grossly unfair to investors who bought Facebook stock on the IPO (or at any time since) and didn't know about it.

At worst, it's a violation of securities laws.

This latest chapter in the Facebook IPO story began this morning, when Reuters' Alistair Barr reported that the research analysts at the company's lead underwriters—Morgan Stanley, Goldman Sachs, and JP Morgan—had cut their earnings estimates for Facebook during the company's IPO roadshow. This was highly unusual, if not unprecedented (I've been in and around the tech IPO business for almost 20 years, and I've never heard of it happening.)

Analysts cutting estimates is generally regarded as significant negative news for stocks. This is especially the case when the analysts who cut their estimates are very close to a company—and, therefore, are thought to have particularly good information.

(In the old days, before the implementation of Regulation Fair Disclosure, companies used to manage the market's expectations by telling trusted analysts to change their estimates. Reg FD banned that practice.)

The fact that some potential Facebook investors were told of the analysts' estimate cuts and others were not would seem to be a major "selective dissemination" issue.

It is inconceivable that a reasonable investor would consider the sudden reduction of the underwriter analysts' estimates to be immaterial to an investment decision.

The SEC and FINRA appear to have acknowledged this, and they may now investigate what happened.

More broadly, everyone is still trying to understand what happened with the pricing of the IPO, which was hyped up to be the offering of the century. We now have some more information on that.

Given the PR and legal disaster that the Facebook IPO is rapidly becoming, most official communications channels have gone silent. Facebook declined to comment. Morgan Stanley did not return a call and email seeking comment.

We have spoken to several sources familiar with aspects of the transaction. We do not have complete details yet, but a general picture of what happened is starting to take shape. For now, please regard most of the information below as scuttlebutt, as it has not yet been confirmed.

The story we are hearing is this...

THE FACEBOOK IPO

WATCH: How Low Will FB Stock Go?

In early May, as Facebook prepared to kick off its IPO roadshow, the research analysts at the company's lead underwriters developed financial forecasts to facilitate the marketing and pricing of the IPO.

Such estimates are usually developed through close collaboration between the underwriters' research analysts and company management. These estimates are viewed by sophisticated investors as having been "blessed" by the company: They are perceived as revenue and earnings targets that the company has reviewed and is confident it will hit. Sophisticated investors use these estimates when they are developing "bids" for the stock, as a tool with which to help determine the price they are willing to pay.

Importantly, these estimates are not published anywhere.

Rather, in conjunction with industry convention (see below*), these estimates are conveyed verbally to institutional investors who are considering investing in the IPO.

(This is an absurd and unfair practice. The estimates themselves are material information--the consensus of smart, well-trained analysts who have worked with the company's management to develop realistic forecasts. Most investors don't even know that these estimates exist, let alone that they're whispered verbally to only a handful of big investors. All potential investors should have easy access to these estimates, as well as to any logic underlying them. The SEC needs to change the rules here.)

The same development and dissemination of estimates also happened with Facebook.

As the Facebook roadshow began, institutional investors who were considering investing in the stock were verbally given the underwriters' initial estimates for the company. And, initially, there was a lot of institutional enthusiasm for the stock.

Several days later, however, on May 9th, Facebook filed an amended IPO prospectus with the SEC.

This prospectus contained new disclosure language that had not previously appeared in Facebook's SEC filings. The language was on page 57 of the prospectus, in a section discussing the company's recent financial and user trends:

Based upon our experience in the second quarter of 2012 to date, the trend we saw in the first quarter of DAUs increasing more rapidly than the increase in number of ads delivered has continued. We believe this trend is driven in part by increased usage of Facebook on mobile devices where we have only recently begun showing an immaterial number of sponsored stories in News Feed, and in part due to certain pages having fewer ads per page as a result of product decisions.

The appearance of this language unnerved some sophisticated investors and analysts, who took it as a sign that Facebook's business might have deteriorated. The language was vague, however, and it did not make clear that Facebook's second quarter was weaker than expected. (To infer that message from the language, you had to know that Facebook's first quarter had been weak--and that the cause had been the divergence between user growth and revenue growth.)

Soon after Facebook amended its prospectus, all three analysts at the company's lead underwriters—Morgan Stanley, JP Morgan, and Goldman Sachs—cut their estimates for Facebook's Q2 and the full year.

These estimate cuts were conveyed verbally to sophisticated institutional investors.

And, not surprisingly, these investors viewed the estimate cuts as a startling and negative development.

One important question, of course, was why all three underwriter analysts cut their estimates.

Had they all read the new sentence in the prospectus above and realized that the second quarter was weak? Or had they been tipped off?

It seemed inconceivable that all three analysts could have read the language above and concluded independently that Facebook's Q2 was weak and therefore decided to take the highly unusual step of cutting estimates in the middle of a company's IPO roadshow.

More likely, it seemed, someone had directed the analysts to cut their estimates—most likely someone with inside knowledge of how Facebook's Q2 was progressing.

And we have now heard from one source that that is what happened.

One of the underwriter's analysts has said he was told by a Facebook financial executive to cut his estimates.

According to another source with insight into the Facebook IPO process, until the underwriters' analysts cut their estimates, demand for Facebook's stock among sophisticated institutional investors was high. Once these investors heard about the estimate cut, however, they became more cautious about the IPO.

(Again, an estimate cut like this during a roadshow would be hard to interpret as anything but negative. One institutional investor I spoke to said he has looked at more than 1,200 IPOs over the course of his career, and he has never heard of this before. This is especially true because the underwriter estimates aren't really "estimates"--they're more like company guidance.)

The estimate cut, moreover, was followed by three additional pieces of information that were interpreted negatively by some institutional investors:

1) The price range for the deal was increased, which made the deal even less attractive in light of the estimate cut,

2) The size of the deal was increased, which meant that more stock would be sold, and

3) Many smart institutional Facebook shareholders like Goldman Sachs decided to sell more stock on the deal—the "smart money," in other words, was cashing out.

Meanwhile, during private roadshow meetings, Facebook executives were reportedly "signalling" to some sophisticated investors that Facebook's advertising revenue would not grow as rapidly as some potential investors had hoped. Facebook's advertising business is driven primarily by company-to-company sales efforts, not by the self-serve ads that drive Google's business. Facebook executives reportedly made clear to sophisticated investors that this would limit the rate at which Facebook's ad business could grow.

By the second week of the roadshow, after the estimate cut and price increase, some institutional investors became more cautious about the IPO. According to one investor who looked at the deal, institutions "got the willies" and started to talk about paring back their stock orders.

Meanwhile, out in the real world, demand for Facebook stock was hitting a fever pitch. One senior stockbroker at a major brokerage firm reported that he "had never seen such demand" for an IPO.

These individual investors, needless to say, were not likely aware that the research analysts at the company's lead underwriters had cut their estimates for the company. They were also, presumably, unaware that Facebook's Q2 was weaker than expected.

At the end of last week, the time came to decide on the IPO price for Facebook's stock.

This process was handled by Facebook's lead underwriter, Morgan Stanley, and Facebook executives.

According to one source (unconfirmed--this really is just scuttlebutt), based on the book of orders submitted by both institutional and retail investors, Morgan Stanley found that there were two distinct price levels at which investors were interested in buying stock.

Institutional investors, having digested the news of the underwriter estimate cut, were comfortable buying Facebook stock at $32 a share.

Retail investors, meanwhile, who were presumably unaware of the estimate cut, were comfortable buying Facebook at $40 a share.

Knowing that a big percentage of the IPO stock could be sold to retail investors instead of institutional investors, Facebook and Morgan Stanley decided to price the IPO at $38.

(UPDATE: Another source, closer to the situation, tells us that this scuttlebutt is wrong. Morgan Stanley was overwhelmed with demand, the source says. There was more institutional interest at lower prices--i.e., institutions were willing to buy more stock at lower prices--but there was plenty of institutional interest up to $40 and beyond.)

Although the precise allocations could not be learned, a source says that Morgan Stanley allocated a far larger percentage of the Facebook deal to individual investors than is normally the case in an IPO like this.

On Friday, May 18th, Facebook's stock opened at $42. It spent most of the day above $40, giving short-term traders a chance to flip for a quick gain, and then sank quickly. With heavy support from Morgan Stanley, the stock closed on Friday at just above the IPO price.

Given the amount of stock that had been sold, Morgan Stanley could not support Facebook's stock price indefinitely without exposing itself to huge losses. In two trading days this week, as the IPO hype wore off and news of the analyst-estimate cut spread, Facebook's stock plummeted.

The stock closed today at just over $31 a share, about the price that institutional investors were reportedly comfortable paying for it.

The SEC and FINRA have already said they may look into the Facebook IPO process. The Massachusetts Secretary of the Commonwealth has also just announced that has subpoenaed Morgan Stanley over the issue.

So, at some point soon, we will likely get the full story.

In the meantime, it's hard to conclude anything other than this:

In one of the biggest IPOs in history, in which a huge amount of stock was sold to small investors, privileged Wall Street insiders once again got top-notch information...and individuals got the shaft.

UPDATE: Reuters' reporters Poornima Gupta and Alexei Oreskovic have uncovered the before-and-after Facebook estimates that were verbally conveyed to big investors (below). As you can see, both sets of numbers are carefully coordinated across the firms. There is no way that the estimates would be this close without explicit direction from Facebook. There is also no way that an investor could get this information from Facebook's IPO prospectus. These disclosure rules need to be changed...

Here are the detailed figures from the four banks, according to one of the investors who received the new numbers.

Lowered full year revenue estimate for 2012

Morgan Stanley -- $4.854 bln (new)from $5.036 bln (old)

Bank of America -- $4.815 bln (new) from $5.040 bln (old)

JPMorgan -- $4.839 bln (new) from $5.044 bln (old)

Goldman Sachs -- $4.852 bln (new) from $5.169 bln (old)

Lowered estimates for second-quarter 2012

Morgan Stanley -- $1.111 bln (new) from $1.175 bln (old)

Bank of America -- $1.100 bln (new) from $1.166 bln (old)

JPMorgan -- $1.096 bln (new) from $1.182 bln (old)

Goldman Sachs -- $1.125 bln (new) from $ 1.207 bln (old)

Lowered 2013 Earnings per share estimate

Morgan Stanley -- 83 cents (new) from 88 cents

Bank of America -- 64 cents (new) from 66 cents

JPMorgan -- 66 cents (new) from 70 cents

Goldman Sachs -- 63 cents (new) from 68 cents

* Several readers have asked why underwriters are allowed to verbally disseminate analyst estimates to big clients. This is an excellent question. The short answer is that they shouldn't be allowed to: It's very unfair to anyone who doesn't happen to be a big client.

The reason this rule developed, ironically, was to protect small investors from sleazy brokerage firms that might hire analysts to publish puffed-up estimates only to sell a deal. Big investors, the thinking went, were grown-up enough to be able to evaluate the estimates for themselves, whereas smaller investors weren't.

The Law of Unintended Consequences then led to the current situation, which is worse: Institutions get highly material estimates shaped by the company. Small investors don't.

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