Facebook Flop or Not?

Facebook went public on Friday. After months of build up, there were some issues with trading, and finally, no big pop in stock price. This has led some media pundits to conclude that Facebook’s IPO was a flop. But was it really?

Facebook IPO Trading

Facebook’s IPO was not necessarily typical. However, there was little typical about it before it even began. There was the sheer size of the offering, making the Facebook IPO one of the largest of all time. Then, there was the intense media interest, which, believe it or not, is not typical of initial public offerings.

The idea that Facebook’s IPO was a flop revolves around the concept that its stock price did not rise on its first day of trading. Indeed, there was ample evidence that Facebook’s underwriters were forced to step in and prop up the share price to keep it above the $38 offering price. Whether this is a flop or not depends on whose shoes you are in, and how much you care about what normally happens.

Facebook IPO Pricing

In the days leading up to the IPO, there was some concern that the price for Facebook stock was too high. After all, the top of the trading range gave the company a valuation nearly 100 times its earnings. By that measure, it was one of the priciest stocks around. Typically, a 100 times earnings valuation requires enormous growth potential. While Facebook certainly has growth potential, there aren’t many analysts out there looking for earnings to triple by next year, which would be the kind of growth that usually commands 100x pricing.

However, there was enough demand (or someone thought there was enough demand) to raise the IPO range, and to eventually price the initial shares at $38.

Here is where it gets complicated.

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Facebook, the company, and the Facebook investors who were raising cash by selling the shares they owned of the private company are the only people who “sell” at the $38 IPO price. These are the offering shares. As a result, the money the company makes is equal to the number of shares it sells times the IPO price.

In other words, no matter how high the stock price goes after the first trade, the company itself will get no more money. So, if the shares went to $40+ (they did for a while), the company still just got $38 per share.

The fact that Facebook shares did not go up from the IPO price suggests that Facebook, itself, got every single penny it could from its IPO. That makes Facebook a big WINNER in this IPO.

The underwriters are paid by the company issuing the IPO. This payment is a percentage of the IPO amount. It also had nothing to do with the share price after the market opens. In this respect, the underwriters are like the house in Vegas. They win no matter what happens to the stock price.

Who Got Burned By Facebook IPO

So, if Facebook and its investors did just fine with the IPO, who is complaining?

Most IPOs are not so popular. In fact, most IPOs happen without any fanfare. They are filled by institutional buyers and large clients who buy the stocks based on the fact that the underwriters (the Wall Street bankers) deliberately attempt to price the initial public offering at a slight discount to the actual value of the stock. In other words, Morgan Stanley, for example, would price an IPO at $25 per share if it though the company was actually worth $30 per share.

The reason this happens is that otherwise there would be no motivation for anyone to ever buy an IPO. After all, you can buy the same shares seconds later on the open market. The only reason to buy into an IPO is the possibility that those trades that come seconds later do so at a profitable price for those who took IPO stock.

The people buying into the Facebook IPO were, of course, hoping for this initial increase in share price, often referred to as a pop. It never really happened. These IPO buyers are the ones feeling burned right now, because they got nothing for buying into the Facebook IPO.

In fact, the underwriters had to buy shares on Friday in order to keep the price above $38 per share. This is to prevent a first day loss, which might be embarrassing and make it look like they mispriced the IPO in the first place. In this respect, the underwriters lost a little bit, but it was mostly egg on the face and not any real loss.

Keeping the stock price above the IPO price is only the underwriter’s job for the first day of trading, so it is no surprise that Facebook stock dropped on Monday without the artificial support.

Why Did Wall Street Mess Up the Facebook IPO?

Again, Facebook is not upset about its IPO. In fact, it has to be pretty pleased that it got as much money as possible out of its IPO. There is a good argument to be made that this whole thing might be Facebook’s “fault.”

Remember that Wall Street firms were tripping over themselves to get a piece of this IPO. Also remember that several reports said that Facebook got rock bottom fees from the bankers involved in its IPO. Is it too big of a stretch to think that they may have had some say in the pricing as well. Perhaps the company was not willing to take the standard “pop discount” and instead insisted on pricing its stock much closer to the actual demand.

Either way, Facebook is now a publicly traded company. Where the stock goes from here is up to future investors, not the IPO players.


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