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 realised 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 realised 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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