The second day of Facebook (FB) trading was even worse than the first day. The stock closed at $34.03, down $4.20 (-10.99%). The mega offering of stock is still the talk of Wall Street, and as expected, every expert has been offering up reasons for the stock’s disappointing debut.
Some background will help put things into perspective. In an IPO, underwriters are primarily responsible for setting the initial valuation of the company and distributing stock to investors in an orderly fashion. Obviously, the higher the valuation (the stock price times the total shares of the company), the more money the company (and selling shareholders) will receive. From the investor’s perspective, the lower the price, the greater the chances that the stock will “trade up” after it opens on the first day.
What is the right price, you ask? It is the price at which the company and investors can be satisfied. What one gains, the other loses, so it is sometimes a contentions negotiation.
In the case of FB, the underwriters led by Morgan Stanley did two things just prior to the IPO that were controversial, in retrospect: it increased the price of the offering and increased the number of shares for sale. If demand had been stronger for the stock, these moves would not have been questioned.
The “book” for the stock (or orders compiled by the underwriters) did not enable the underwriters to maintain the IPO price after it opened on Thursday. And so, it declined on the first day. Rumor has it that the underwriters supported the stock by buying shares on the open market; this caused the first day loss to be relatively small.
Note: Historically, the price of technology IPOs has risen significantly on the first day of trading. So, the FB performance was particularly disappointing.
On the second day, underwriter support probably waned, and while the overall market surged, FB fell nearly 11%. Some of the reasons expressed by market analysts include the following (not in any order of importance):
- FB’s mobile business may cause it to have a lower adverting revenue growth rate because mobiles do not display advertisements. Ads account for the lion’s share of FB revenues.
- General Motors cancelled $10 million of advertising. Seemingly, this is a small amount compared to over $3 billon of revenue in 2011, but GM is a savvy buyer of ads. It may not believe FB postings have the “pop” necessary to justify its ad rates.
- There is a huge overhang of shares that are “lock-up” for six months. Some estimate the number of shares to be nearly 100 million. These represent stock owned by employees and other insiders. If the shares hit the market in size, it could depress FB’s stock price.
- Underwriters cannot afford to support the stock too much longer.
- The FB IPO price was set at too high of a level because earnings growth will not be able to sustain such a high stock price. Note: This may be a “buyers’ remorse comment.
- NASDAQ’s inability to process orders effectively created a cynicism about the stock that depressed its stock price. In effect, the exchange took too long to confirm FB trades.
- The use of proceeds has become an issue. A lot of the $16 billion of IPO proceeds are going to shareholders. Whereas, Google’s $2 billion IPO proceeds when directly onto the company’s balance sheet.
In fairness, the FB IPO was successful in many regards. The company sold a tremendous amount of stock, long term investors were able to cash out, the deal was priced to the maximum level (better for the company than for the investors) and it was completed during a severe market down turn.
I am not backing off from comments made previously about FB. Its operating performance has been spectacular to date. And, it has 800 million customers and new potential customers of about 6.2 billion.
If I wanted to own FB, I would probably wait until after the company posts its earnings for the current quarter and after the lock-up period ended before placing an order to buy stock.