Facebook share drop: more than meets the eye (updated)

Last-minute devaluation by Morgan Stanley pre-IPO proves mobile strategy flawed, as Computing explained last week

It has been widely reported that, at market close yesterday, Facebook's value had dipped by over 10 per cent of its asking price, drawing criticism from lead underwriter Morgan Stanley.

Such is the market-distorting value ascribed to this stock that a day's poor trading creates ripples in the market. When set against IBM's 100 years of history, for example, such moments are absurd.

Of greater interest, however, is the fact that Morgan Stanley reduced its forecasts shortly before IPO.

The underwriter's reevaluation came towards the end of Facebook's IPO roadshow, when the company itself admitted concerns about future profitability in the face of users' shift to mobile - a platform Facebook will find difficulty in monetising in terms of advertising revenue.

It seems extraordinary that such a caveat should be added to a company's prospectus mid-roadshow - an event with few, if any, precedents in tech stock flotations - when the social network's mobile business model must have been discussed for years.

And with the Facebook IPO not even a week old, the writs have already hit the fan, with a lawsuit aimed at Morgan Stanley, Facebook and its founder Mark Zuckerberg already filed. The lawsuit accuses them of concealing the company's weakened growth forecasts ahead of the IPO on Friday.

Morgan Stanley is also facing an investigation over possible securities fraud. It is accused of not warning all investors of a more negative assessment of the company's prospects produced by one of its own analysts. While clients of the bank received the research, other potential investors remained uninformed.

Analyst Scott Devitt had cut his forecasts for Facebook's annual revenues from more than $5bn (£3.2bn) to $4.85bn (£3.1bn). He also suggested that the company's business model faced a number of challenges.

Facebook shares have fallen every day following the botched IPO, even though Morgan Stanley has supported the price by purchasing stock. The Daily Telegraph suggests that the bank may have spent so much money trying to maintain the company's stock price that it had spent almost all of the bank's fees from the deal.

Morgan Stanley has defended its actions. In a statement, it said that it had acted "in compliance with all applicable regulations".

Computing had seen the writing on the wall in its trio of analyses last week, questioning Facebook's valuation. These reasoned that the chasm between the company's market value and annual profitability would begin to deter mature investors, while Facebook's stated intention to focus on mobile seemed a plan lacking in substance, given the severe challenges in its desktop advertising model.

So the question remains: how aware was Facebook of deep-rooted problems when it went ahead with its stratospheric IPO - a launch for which it had built a financial cliff via a raft of last-minute announcements?

With a valuation that rests, logically, on the platform's potential for future development rather than its success to date, many analysts agree that Facebook is going to have pull something major out of the hat.

It has the money to make acquisitions, of course, but what it really needs is a coherent strategic roadmap to turn its (soon to be) one billion users into more than a few pennies apiece in annual revenues.

As a mature business, this bellwether stock (in terms of its cultural import and popularity, at least) needs to map out a long-term vision and take both users and investors on a journey towards that vision, to prevent its share value from spiralling to the ground.

Were Facebook to burst a bubble of its own making, the knock-on effects on the tech sector could be severe. If that happens, then it will have only itself to blame, along with some institutional backers that should know better than to pursue an all-too-visible high-risk strategy.

Additional reporting Peter Gothard