Facebook sinks as much as 14%
Morgan Stanley propped up Friday's IPO, but the lead underwriter couldn't fake the stock price forever.
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 email@example.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
(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.....
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 ...
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.
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