Shine Is Off Wall Street's Big Bet on Internet Start-Ups

Mark Lennihan/Associated PressNews about Facebook appeared on the ticker at Morgan Stanley’s headquarters in Manhattan.

4:29 p.m. | Updated

In early 2011, it seemed like easy money.

As the valuations of Internet start-ups like Facebook and Twitter skyrocketed on the secondary markets, scores of investors rushed to capture a piece. The big Wall Street banks were no exception.

JPMorgan Chase opened the optimistically named Digital Growth Fund, a $1.2 billion account. Goldman Sachs made a direct investment in Facebook — to the tune of half a billion dollars. Morgan Stanley’s mutual funds, meanwhile, bought millions of shares in the online game company Zynga before its initial public offering.

Though promising at the time, nearly all those bets have soured.

Zynga’s shares have plunged 70 percent from the offering price. Shares of Groupon, once heralded as “the fastest-growing company ever” on the cover of Forbes magazine, are off more than 70 percent, closing on Thursday at $5 a share. And the golden child of the new Web, Facebook, is struggling to persuade investors to hold on. Its stock has lost more than 47 percent of its value, and many fear it could stumble further in the coming months as shareholder lockups expire, potentially flooding the market with more and more Facebook shares.

On Thursday, Facebook’s first lockup expired.

Investors who sold during the initial public offering — a group that includes Peter Thiel, one of Facebook’s earliest backers, Accel Partners and Goldman Sachs (Mark Zuckerberg, the chief executive, is excluded) — are now free to sell about 271 million shares.

Shares of Facebook slipped below the $20 mark on Thursday, falling about 6 percent to close at $19.87. Between now and May 18, 2013, there will be four more waves, a chilling prospect for prospective investors.

Though the jury is out on how these young businesses will ultimately fare and whether the investments of 2011 will turn to busts, Wall Street’s biggest investors still have plenty of skin in the game.

Morgan Stanley, for instance, the lead underwriter for many of these stocks, purchased millions of shares in companies like Zynga, LinkedIn and Facebook at their initial public offerings, and in some cases, before. In February 2011, it bought more than five million shares in Zynga at about $14 a share. According to a filing submitted earlier this month, its mutual funds still own about 32 million shares, or about 6.9 percent of Zynga’s class A stock. The firm has also made big loan commitments, with more than $1 billion earmarked for Facebook and about $250 million pegged to Zynga, according to people with knowledge of the matter.

Shares of Zynga fell slightly on Thursday, closing at $3 a share.

Goldman Sachs, which has also agreed to provide substantial loans to Facebook and Zynga, led a $1.5 billion investment in the social network in January 2011 at a $50 billion valuation. While most of that block went to its international clients, Goldman made a direct investment of nearly $500 million. Entities affiliated with Goldman, including the direct investment and its private clients, managed to sell 28.7 million shares in Facebook’s I.P.O. at $38 a piece — a profitable outcome.

The firm, however, is still holding 37.3 million shares. It is less certain whether Goldman will make any money on this remaining block. It paid about $20 a share for its January investment, according to a person with knowledge of the deal, who requested anonymity because the terms of the deal were private.

Representatives for Goldman Sachs and Morgan Stanley declined to comment.

JPMorgan, with its formidable balance sheet, has also been active.

The bank, which secured a surprise No. 2 spot in Facebook’s I.P.O., has about $1.6 billion in loan commitments to Facebook, according to one person close to the firm. Earlier this year, Facebook announced that it had expanded its credit facility to $5 billion and had received a $3 billion bridge loan. The firm’s exposure to Zynga is far smaller. It has agreed to provide about $195 million in loans, this person said.

JPMorgan may end up losing more money from its Digital Growth Fund, which has large investments in Twitter and LivingSocial. Although LivingSocial, the daily deals site, had raised hundreds of millions of dollars at a valuation above $3 billion, its fortunes have slipped in lock step with those of Groupon, a far larger rival. Amazon.com, which owns a 29 percent stake in the company, recently wrote down the value of its investment to $271 million.

JPMorgan has also lent about $40 million to LivingSocial, the person familiar with the matter said.