Well that certainly didn’t go as planned.
Months of hype and then on the big day, Facebook’s (Nasdaq: FB) IPO was delayed by technical difficulties. When trading finally began, shares rose from $38 to $42, before settling back in at $38.
Shares didn’t see support at $38 “naturally,” either. Instead, the underwriters who ushered Facebook to market bought shares at that price to provide support artificially.
I don’t know if it qualifies as a total disaster, but at the very least it deserves a “Dislike.”
Not to mention the collateral damage…
When Facebook shares didn’t rocket, the market reeled. Especially Facebook’s fellow social networking companies, Zynga (Nasdaq: ZNGA), LinkedIn (NYSE: LNKD), Groupon (Nasdaq: GRPN) and Yelp (NYSE:YELP).
Since investors didn’t display a raging appetite for Facebook shares, the growth priced into social networking stocks suddenly seemed too high and investors headed for the doors. (After all, these stocks are trading at valuations that could only be attributed to The Greater Fool Theory. And on Friday, some fools started getting a little less foolish.)
But those who claim that Facebook’s stumble is indicative of a top in the stock market – or even just a top in tech stocks in particular – are searching in vain for an oracle that doesn’t exist. No stock’s single-day IPO performance indicates anything about the future, or even the current state of the markets.
You see, when a stock goes public, the underwriters try to predict how much stock investors want to buy. If they guess too low, the price shoots up, representing lost money that the company going public could have claimed. If the underwriters guess too high, they end up holding a bunch of unsold shares.
In this case, the Facebook IPO was so talked about and hyped that those who were allowed to request allocations asked for more than they actually wanted, expecting to end up with fewer shares than they asked for. In turn, Facebook’s underwriters (Morgan Stanley) got a false sense of demand and chose to sell 421 million shares at $38 a pop. As a result, the price corrected downwards.
For that reason alone, Facebook’s fall doesn’t signifies that tech stocks are done, or even that Facebook was overvalued (though I agree with our own Louis Basenese that it is, in fact, overvalued). All that it indicates is that a small group of underwriters made a bad judgment on the initial pricing.
Likewise, had Morgan Stanley sold 400 million shares instead of 421 million, shares could have risen and we’d be telling a different story.
In any case, mispriced IPOs aren’t rare. They happen all the time. Over the last year, IPOs have been “underpriced” by an average of 9.7% based on the difference between their offer price and where they first trade on opening day. Results this year have ranged as far as AVG Technologies (NYSE: AVG) immediately dropping 15%, to Zillow (Nasdaq: Z) opening 200% above its offer price.
Let’s be clear, I’m not suggesting that you invest in Facebook or any of its social networking brethren. But I believe that if you dump your quality tech stock holdings based on Facebook’s one-day performance, you’ll be sadly mistaken.
In the end, a difference of opinion between the underwriters and the investment public doesn’t suggest any change in investor sentiment or anything about the economy. It simply shows that pricing IPOs is an imperfect science.
Courtesy Matthew Weinschenk at Wall Street Daily (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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