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Interview With IPO Analyst: What Went Wrong With Facebook Debut and What It Means…

| May 18, 2012
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Besides creating the potential for a new crop of 20-somethings to block your driveway with their Lamborghinis, the Facebook IPO has some other significant consequences riding on it. Like revenue for the state budget, local real estate prices, and the general Bay Area economy.

That may diminish whatever Schadenfreude you — who can’t afford face cream right now let alone Facebook — may be feeling over the following headlines referring to Facebook’s big debut:

Those all refer to the fact that shares of the highly anticipated offering finished just about a half-percent over the opening price — and only with the help of big buy orders from the underwriter, to boot. The Big Facebook Bang was also marred by trading glitches on the Nasdaq exchange.

A couple of days ago Sam Hamadeh, CEO of IPO research firm PrivCo, handed us seven reasons to sit out the Facebook IPO. Now that the IPO has launched, Hamadeh thinks the entire thing was a bit of a fiasco. Here’s an edited transcript from my interview with him after the bell…

JON BROOKS: So what happened today?

SAM HAMADEH, PRIVCO CEO: The first trade was expected to go at 10am ET; at 9:15 early indications of the first clearing price was $45 per share. Once that price hit the tape, a lot of new sell orders came in hoping to get that price. That gradually kept ticking the shares down, unexpectedly. So they changed the first trade to 11 a.m.

Obviously this is an enormous disappointment for people in the Bay Area… I think this probably represents the closing of the IPO window for awhile…

Throughout the day it seemed like a lot of people got extremely nervous. A lot of people were expecting an easy flip, that the stock could go up 50% or maybe 100%, and once that clearly wasn’t happening, it very rapidly started to approach the IPO price of $38 per share. The underwriters actually had to step in and put in what are called supporting bids.

It’s a standard part of the agreement that if necessary, underwriters will step in with their own capital and provide liquidity in the first hours or couple of days of trading.

All through the last half hour of trading you saw it trading consistently at 38,38.01, and all those buy orders were coming from the underwriters. They were effectively artificially supporting the price. Without them stepping in, the stock would have clearly dropped below the IPO price in what’s called on Wall street a busted IPO, a trade below the offering price.

It’s a big disappointment for almost anybody. But I can’t say we were shocked given it was so overvalued.

As to why this happened, one of the missteps was first raising the price range. That clearly would have left some upside for other people. They got a little too greedy. Then two days ago, increasing the total offering by 25%, adding another $4 billion dollars-plus to this offering, really left almost no one left who didn’t get to buy. And without anyone left, there just wasn’t the demand there to support the stock. Very stunning development for most observers.

JON BROOKS: How common is it for underwriters to have to step in to support the price?

SAM HAMADEH: It’s not unusual to make the guarantee, but it is unusual to have to make good on it. The last major example is Zynga’s IPO in December, when it went public at 10, shares immediately started plummeting and underwriters stepped in with a supporting bid at 9. It closed just above 9 per share. Still a busted IPO.

Clearly they had to step in today, and it augurs poorly for what will happen to the stock once that implicit guarantee goes away.

One thing to keep in mind, with an $18 billion float, there were 550 million shares traded today, which was bigger than the offering. That means every share traded hands 1 ½ times. The underwriting fee pool was only $190 million. So the underwriters can’t risk more than they made on the deal. Their ability to keep it at $38 was very limited by just the size of it.

JON BROOKS: What about the dive in related social media stocks like Zynga, Pandora, and LinkedIn? How do you interpret that?

SAM HAMADEH: There’s no question that companies had risen the last couple of weeks based on an expected Facebook IPO pop, or at least not fallen as much as they otherwise would have. I think a lot of investors got nervous once it became clear this pop wasn’t coming; you saw a lot of shorting on those stocks.

Facebook isn’t shortable; it doesn’t have options that trade on it. So if you’re trying to hedge, or lets’ say you’re an employee or an early investor and your shares are locked up for the next six months, the way to bet against Facebook would be to sell other companies as proxy investments.

Zynga is probably the closest proxy investment, given that some 11 to 12 percent of Facebook’s revenues come from Zynga. Around 11:30 a.m., shortly after it became clear that this pop was going to not be a pop but in fact be a fizzle, massive short positions were initiated. In particular, one large hedge fund placed a massive negative bet on Zynga and it caused it to crash 14 percent in a matter of literally 60 seconds. When that happened it triggered Nasdaq rules to halt trading temporarily in any stock that falls over 10 percent in less than five mintues. That happened twice to Zynga today.

Clearly people wanted to get out of Facebook or at least hedge their position in it, and Zynga and some of the other social media stocks were the closest proxy investments to make bets against Facebook.

JON BROOKS: So do you think this is the official popping of whatever bubble there was?

SAM HAMADEH: Obviously this is an enormous disappointment for people in the Bay Area. Even if they didn’t have stock in Facebook, they at least have stakes indirectly in social media companies they were hoping would get acquired, would be able to go public in the summer or after Labor Day, and the halo effect was supposed to carry into Spotify, Branchout, Airbnb and so forth.

I think to us at PrivCo this probably represents the closing of the IPO window for awhile, and any company that’s going to try to go public is going to have to dial back on the proportion of the IPO that represents insider sales. Facebook got pretty greedy at the end, with 57 percent of the offering going to insider selling. That’s a remarkable percentage. There’s only two other IPOs in the past year according to our tracking that had more than 50 percent of the IPO go to insiders.

Second, no more raising the price range every few days. Third, no more raising the amount of shares being offered. All those games are over. Clearly Facebook overreached. I don’t think this is the headline people wanted going into tomorrow’s newspaper.

JON BROOKS: What happens Monday?

SAM HAMADEH: Morgan Stanley looks horrible right now. The Nasdaq looks horrible. There are people who own IPO shares or bought this morning – they haven’t even received trade confirmations yet. There are millions of shares traded that aren’t even technically cleared yet.

Nasdaq did make extra efforts to do a dress rehearsal, looping in all of the regional exchanges affiliated with it. But even with that you had some major hiccups, the trades not clearing, the delay in the opening, the Zynga flash crash. Morgan Stanley’s embarrassed, Nasdaq’s embarrassed. I think they’re going to blame Facebook. They’ll say these guys wer pulled kicking and screaming into this process. Mark Zuckerberg only showed up for two of the roadshow stops and barely took questions. He didn’teven bother to put on a dress shirt.

It was a massive IPO, 550 million shares traded, a new record. They’re going to blame Facebook management.

And they made big compromises. Nasdaq gave Facebook a two –digit ticker symbol — Nasdaq stocks are typically a four digits. They agreed to put them in the Nasdaq 100 a year early. They changed the rules just for Facebook, to get the deal. Morgan Stanley took a massive cut in fees. The fees for this deal were only 1.1 percent; the average IPO fees are between 5 and 8 percent of a deal. They did this becase they were hoping new tech IPOs would come to Nasdaq, Morgan Stanley would have bragging rights, getting it done and everyone making money. That’s all gone now mostly. None of us watching are saying this is a beautifully executed day.

Well, not everyone was so glum. Some other reactions from around the web, Storified by KQED’s Ian Hill.

Also take a look at our Fill in the Blank exercise: I think Faceboo’s $104 billion valuation is…

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    > SAM HAMADEH, PRIVCO CEO: The first trade was
    expected to go at 10am ET; at 9:15 early indications of the first
    clearing price was $45 per share. Once that price hit the tape, a lot of
    new sell orders came in hoping to get that price. That gradually kept
    ticking the shares down, unexpectedly. So they changed the first trade
    to 11 a.m.

    I’m fairly sure very little is right, aside from $45 as the first indicative price. So far as I know price and imbalance information _started_ at 10:45, which was the scheduled time (known on Thursday, maybe earlier) and anyway is the most common time for recent NASDAQ IPOs. And the first trade was supposed to be at 11 (it wasn’t changed to that, this was always the plan), but was in fact to changed to 11:05 and then 11:30. AND, the subsequent change to 11:30 possibly hiding a rather big story; the SEC already is on the case.
      Were Mr Hamadeh’s observations of the IPO, which we can presume he was watching, mis-edited somehow? Such an inaccurate summary of events, wrong on the details and missing the big story, taint the entire interview.

    • Jon Brooks

      We asked  Sam Hamadeh about the points you make in your comment, and he responded this way:

      “Initial start of
      trade as of 9am…was provided to us as 10am (we were at the Nasdaq
      itself). At 9:25, based on heavy sell orders, the exchange revised the start or
      trading to 11am.  First trade finally
      came in at 11:35am.”