Monday, May 21, 2012

Facebook's IPO was Extremely Succesful

The news:  Facebook priced ~420M shares at $38/share, raising $16B for the company and original investors.  The stock traded up almost 10% on day 1 before falling back to the IPO price by the end of the day.  On its second day of trading, the stock dropped below its IPO price and ended the day down around 10%.  Every news outlet is calling into question the "success of the IPO," blaming the bankers, or FB, or the Nasdaq for it.  Let me contradict them all, the Facebook IPO was extremely successful...and anyone who says otherwise doesn't know what they're talking about.

The entire purpose of an IPO is for current shareholders to sell their shares and for the company to raise money for its own operations.  They hire bankers to market their shares to investors, and obviously, they want to get the highest price possible.  The bankers are supposed to sell, and during the IPO process for Facebook, the price where the shares were going to be sold kept rising. They were initially going to be offered as low as $28/share, but the bankers did a great job, and were able to sell at $38 instead. In order to keep customers coming back to the bankers for new IPOs, the bankers do want the shares to jump on the IPO date.  However, bankers don't want the shares to jump too much on day one, or no company will hire the bank to lead its next IPO and the bank risks losing out on IPO business to rivals.  Does that make sense?  Let me explain.
If Facebook’s shares jumped to $60 from the $38 IPO price, then anyone who sold shares at the IPO price to investors, including the company, would be extremely upset.  They just sold 20% of their business for $38/share, when they could have sold it for $60/share.  While this outcome for IPO’s seems to be a common occurrence, in my eyes, this is an IPO failure.  The bank would have significantly underpriced the shares and the IPO-ing company would be very upset. Banks LOVE when this happens.  In this scenario, not only would the bank make its fees, but banks also take many shares for themselves in the IPO process, and they’d sell those shares on day 1 and make a fortune.  Pretty much, if a stock spikes on the day of an IPO, the banks and their friends make a fortune by taking 1 day’s worth of trading risk. 
In Facebook’s scenario, the stock didn’t spike up.  It traded up a bit (10% at its high), allowing those who wanted to make a quick buck to do so.  Every single share that traded on Friday, traded above the IPO price and so every initial investor who sold, made money.  That sounds like a successful IPO to me.  In Facebook’s scenario, after the day was over, its owners and those who sold shares to investors earlier in the day were happy as well.  They didn’t sell their shares at half of their value, and probably got as much as possible out of the IPO, increasing the number of shares they were willing to sell.  Had the stock tanked on the first day, it still would have been a very successful IPO for Facebook, but the bankers and their large investors, would have been very upset.  As this article states, "Generally, bankers favor a more modest rise, say 10 percent, balancing the needs of both new investors who want big gains and current insiders who do not want to leave money on the table." Sounds like a success to me!

We need to dive a little deeper to understand why Facebook's price is now 10% below offer, at $34/share.  Stock prices are determined by matching buyers and sellers at an agreed price, which means that someone is willing to sell shares at $34. Why are sophisticated investors, who purchased shares on Friday at $38, selling them at Monday at $34?  Perhaps they weren't sophisticated, and were just greedy. As this yahoo article states, "Investors were expecting easy money on this one." Perhaps this is Morgan Stanley's fault for selling to hedge funds and short term holders, however, I feel no sympathy for them. These sophisticated investors analyzed the company and thought it was worth more than $38/share...they're obviously not very good investors. I listen to company's pitch to me everyday, and its my job to cut through the sales pitch given by the comapny, and the bank.  I don't begrudge the bank or the company for trying to get the best deal, that's their entire job and what they're paid to do.  Blaming Morgan Stanley for open market trading two days after an IPO is tantamount to blaming them for not manipulating the stock enough.  Their job is to get the highest price, and set up supply and demand so that when the stock opens for trading, it trades slightly higher. They can't be blamed for market movement three days later. Seems like they did a pretty good job to me.
Why is the FB IPO being considered a failure? The sellers got close to the highest price and that's what the banks were hired to do! If the IPO price doubled on day 1, then bankers would be considered a failure in my eyes, and every original FB shareholder's eyes.  The buyers were able to sell and make up to 10% in 1 day if they wanted to, are they really going to complain about that?  Perhaps the media and individual investors wanted the stock to soar, but to me that’s the sign of a failed IPO, not a successful one. 

If I'm Facebook, I'm happy. If I'm Morgan Stanley, I'm also happy, as other companies are probably calling me hoping I'll agree to do their IPOs.   If I'm an investor who decided to purchase at $38/share, I'm a really bad investor....but that's their own fault, not Facebook's or its bankers. Perhaps everyone should just blame the Nasdaq.  No one will be calling them...


JT said...

But didn't they screw over all of their other clients who purchased stock? probably with their recommendation?

Anonymous said...

Great analysis! Much appreciated. When are we going to see your commentary on taking a position with gold versus the euro/yen?

SSS said...

Excellent explanation in easy English.