Facebook sinks as much as 14%

Morgan Stanley propped up Friday's IPO, but the lead underwriter couldn't fake the stock price forever.

By InvestorPlace May 21, 2012 10:20AM
By Jeff Reeves


The talk on Wall Street all weekend was the Facebook (FB) IPO -- but not for the many reasons people would think. Yes, the company pulled off a $16 billion offering to mark the largest tech IPO in history. And yes, the boy wonder Mark Zuckerberg got married Saturday.


No, the big buzz was about how badly Facebook shares would tumble Monday morning after what some people called a propped-up IPO. And tumble they have, down as much as 14% in early trading.

Surprised at the declines? You shouldn't be. Here's the dirty secret about the Facebook IPO and why many Wall Street insiders expected Monday's double-digit drop:

 First, a brief overview of initial public offerings: Basically, when a stock goes public, it does not throw shares willy-nilly to the masses. Rather, it uses an underwriter as a middleman, parceling out shares to lucky investors and orchestrating the process for a fee.


The underwriter is the gatekeeper to an IPO, and in the case of a company like Facebook, the fee for your labor is only part of what you're after. If you have access to FB stock before the general public does, there are large amounts of prestige and power that come with your role.


Take Facebook's lead underwriter, Morgan Stanley (MS). As the gatekeeper, for a hot new stock like Facebook, clients were banging down the door to get in on the action. MS could earn new business with FB as a carrot, or reward the best accounts with exclusive shares and keep them loyal. There are other perks, too, but you get the general idea.


That’s perhaps why the underwriters on Facebook, led by Morgan Stanley, charged a rock-bottom 1.1% fee on the Facebook IPO. That's not chump change, since the roughly $16 billion stock offering dished out $176 million in fees, but the big payday comes from simply having a finger in the Facebook pie.


At least, in theory.


You see, the idea was that Facebook would pop dramatically after shares hit the market -- and your only way to get in on the profits was to play ball with Morgan Stanley and other underwriters. But that didn't happen, and the price people paid for access now doesn't seem worth it. In fact, some investors may feel duped.


Worse-case scenario, of course, would have been if Facebook hadn't just held firm but actually performed poorly as it hit the market. Then what company would trust you to underwrite another IPO if you botched the job so badly? Why would anyone want exclusive shares if they are just going to tank on the first day of trading?


Good thing Morgan Stanley and the underwriters avoided that, right?


And here’s where we arrive to the dirty little secret. That was exactly what would have happened to Facebook if MS hadn't made a heroic effort to prop up the stock price by buying frantically as the closing bell approached Friday afternoon.

Just look at the chart. It was as if natural market forces magically stopped working and FB shares hit an equilibrium. With more than 600 million shares in volume, that is just impossible to credit to natural market forces.


In fact, it appears to me that Morgan Stanley tried to hold the line at exactly $40 to lock in a fictitious 5% gain from the offer price of $38 but realized it would cost a fortune to defend that amount for two hours. After all, if you're buying a few million shares, that extra $2 adds up in a hurry.


In short, Morgan Stanley wanted to save face by going into the weekend with a "gain" in Facebook for its IPO investors. The problem is that the gain was a fiction and the market swiftly corrected Facebook shares Monday morning.


Did Morgan Stanley do anything illegal? Though it may sound unethical and preposterous, it doesn't appear so -- thus far, anyway. That's just the rules of the market, and MS is free to buy and sell shares like everyone else.


But one thing is sure: The black eye that MS is going to get from this botched IPO will last for a very long time. Clients who were promised an exclusive opportunity will jump ship. Some of the shares Morgan Stanley was buying so frantically will never be allocated to a disgruntled client, and the company may wind up eating a hefty loss if Facebook continues to decline.


The good news for regular retail investors? If you were angry at underwriters like Morgan Stanley because they wouldn't give you a shot at those exclusive shares at $38, this is your shot. You can now buy for under $34.


Or, if Monday's losses keep up, maybe even lower.

Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at editor@investorplace​​.com or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff Reeves did not own a position in any of the aforementioned securities.

More from InvestorPlace.com

Facebook is the biggest fraud in the world!
May 21, 2012 11:23AM
LOL- who would be stupid enough to buy this lame stock? Stupid is as stupid does....
May 21, 2012 11:23AM
Personally, I have trouble feeling sorry for FB (or for MS for betting on FB). While I think there is a place for FB, it produces NOTHING. It has a service to some extent but it can only bank on selling advertising for the content that is produced by its subscribers. If it loses its subscribers there is no value for the advertisers and, of course, no FB
May 21, 2012 11:17AM
What is hard to understand? Facebook doesn't not produce anything, therefore the demand is going to diminish by the minutes. They should have left it the way it was. Pretty soon these Facebook executives will sell their shares and jump ship.
May 21, 2012 11:25AM
More and more people are realizing that Wall Street is a manipulated, quasi-casino. Valuations are not based upon sound data and analysis. Too often they are set by emotional, irrational, fad. Wall Street may have all the money, but their credibility is mostly gone. 
May 21, 2012 11:21AM
Don't you see Facebook's stock dropped 14%  just in the 2nd day.  Ask yourself a simple question, does Facebook worth $100 billions,  of course not,  the company just has some web design engineers, computers, servers and survive only by the advertise,  Facebook does not have a real products as Apple Inc,  Facebook soon will fade out as Yahoo.  So do the math and think about that, don't burn all your money in these kind of company
May 21, 2012 11:13AM
Why would anyone want to buy shares of this company???  Where is the value of social networking?  It is like selling the Emporer's new clothes.
May 21, 2012 11:45AM
If you think social networking is going to make you rich, you're better off investing in yourself.
May 21, 2012 11:40AM
OK, Lemme see if I got this straight....

(ahem)....Charge investors thousands upon thousands of dollars in investment fees, only to turn around and help them lose even MORE money on IPO stock worth far less than the announced value, and then keep the money I made off of the investors, and not worry about anyone asking me for a refund....

Yep...I'm definitely in the wrong business.....

May 21, 2012 11:44AM
FB should have been a penny stock at best! If you bought it, sorry, your money would be better spent in Vegas! They make nothing, they have nothing, there are no assets associated with FB! There is no way their stock could be valued more than GM, FORD, Hewlett Packard etc. Come on people use a little common sense!! Get out while you can!
May 21, 2012 11:35AM
If you bought Facebook.. Sorry folks, but you sure made the CEO and his management team wealthy.
May 21, 2012 11:40AM
Never should have been allowed to be publicly traded anyway. It's a company built out of thin air. It has no tangible assets, does not manufacture anything. The only ways they have of generating revenue are selling ads and charging their customers. I see the stock dropping under $10 in six months.
May 21, 2012 11:14AM
So, Zuckerberg only makes $18B instead of the anticipated $20B?   Sorry, can't feel sorry for the Newlywed!
May 21, 2012 11:36AM

I guess you can't fix STUPID ! 

 Mr. Zuck just married his oriental honey so he can get Singapoore citizenship and ride into  the sunset tax free ... And people will get stuck with worthless piece of paper that tells them that their pipe dream just vanished !!!   

facebook ? face - what ??  LOL !!

ANother Pyramid goes down...   Human greed has no end ...

May 21, 2012 11:15AM
Wow, who would have thunk it? I've been saying this since the IPO was announced, there is no way Facebook is worth what they say. It's a bubble that can't be sustained. A majority of their revenue comes from advertising. The problem with this is, no one clicks on the advertisements on Facebook. I spent the weekend asking friends and family that use Facebook if they ever actually clicked an advertising link, there was only one person who said they did and that it was only once. It's only a matter of time before their advertisers realize that their advertising on Facebook is effectively, ineffective. GM pulled their contract and I'm going to predict that many others will follow. Not to mention, why pay Facebook for ads if they can just create a Facebook profile for their company for free and have people "like" them. It's a very difficult model to maintain a reliable source of revenue from. Also, most people use Facebook on their smart phones, the issue with this is, the Facebook app has no advertisements on it.
May 21, 2012 12:07PM

Any one who bought stock in a company that actualy produces nothing in the real world and employ's almost no one ... deserves exactly what they get ... you bought stock in a cyber fad.

  and as more people are realizing the levels of our privacy that have been taken from us ... they are also realizing that putting personal information out on the web of any kind is becoming a liability and a risk they cant afford to take.

May 21, 2012 11:26AM
This was predictable.  Watch for changes to Facebook that we probably won't like.  They now have stockholders to appease. 
May 21, 2012 11:20AM
Haw haw hawww...remember the Tech Bubble?  Buy stocks that are worth more than just Speculation.
May 21, 2012 10:54AM
The CNBC squawk Box cast is so nauseating to watch this a.m.as they whine like little cry babies over FB stock. lol.
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