Facebook IPO drama: conspiracy or mispricing?

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Everyone is suing everyone. Everyone is upset with everyone. Everyone is blaming everyone.

Get over it. It’s history. The biggest IPO since Google has happened. Some made millions. Others lost even more. Someone got it wrong, and they’re to blame, right?

It’s doubtful that this was some deep-rooted, intricate, secret conspiracy by investment banks to overprice Facebook stock. But the mispricing cost it.

Morgan Stanley as lead underwriters (and the others) spent billions propping up the stock price to ensure that it closed above the IPO price of $38 on day one. That’s a simple cost to figure out. Beyond that though, there is real reputational damage that isn’t going to go away anytime soon.

It was not in the underwriters’ interests to get this so wrong. Pricing at the low thirties would’ve (based on what we know now) ensured a pop to the mid-high thirties. The banks would’ve walked away looking like heroes (and geniuses).

The smoking gun is the news in the market about Facebook’s far weaker-than-expected second quarter trading. This had a big role to play in what happened to pricing ahead of the first day of trading.

Having this news in the market is a big legal problem for Facebook. If — and this is a huge if — it can be proved that a Facebook executive told analysts that business was weak, there could be serious repercussions for Facebook. But the trick is proving this. That’s a lot harder than it seems.

So, we had institutional investors who all knew that trading in Q2 was weaker than the original projections. This didn’t necessarily affect demand outright.

Demand didn’t evaporate. But it did affect the price at which the institutions were comfortable buying Facebook stock. And it wasn’t near the US$38 that Facebook and Morgan Stanley settled at.

Obviously, in theory it’s in their interests to price the IPO as high as possible. In theory, it means more money.

And in practice is meant more money raised for Facebook. Demand from retail investors pushed that price into the forties on day one -– remember, institutions (big money) were only willing to buy in the low thirties because of what they knew.

And then it all unraveled. Well, not before some artificial propping up at the end of day one.

Through last week, the price settled (some would say plummeted) in a range the institutions were more comfortable buying. And it’s not even clear that appetite is as large as it was before all the bad news started being priced in.

It’s quite simple. The easy money was made way before the public could participate.

The money was made on secondary markets earlier this year. Ironically this contributed to the mispricing of the IPO. Demand — which on secondary markets is horribly skewed because of limited supply –- was dramatically skewed. Before trade was halted in March, Facebook shares traded above US$40.

That’s when the easy money was made. The smart people have been cashing out all along.

And then you get idiotic valuations like this: Facebook’s stock should trade for US$13.80.

We’ll know the answer in a few months when Facebook reports its second quarter numbers. This will give us real information which will allow the market to price the company more accurately.

And you can be damned sure Mark Zuckerberg, Sheryl Sandberg (COO) and David Ebersman (CFO) are obsessed with one thing and one thing only over the next five weeks. They absolutely have to beat the downwardly revised estimates caused by the ostensible leak.

We’ll know on 23 July.

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