NEW YORK — The botched offering of Facebook stock has raised several troubling questions, but at least we don't have to worry about the one that plagues many IPOs: How are a few select investors able to buy in early at lower prices and then pocket huge profits when the trading frenzy begins?
Among the many apparent missteps in its public debut, Facebook is accused of setting an opening price that was too high. Instead of spiking on the first day, shares inched up just 23 cents, to $38.23. The stock has mostly fallen since.
But some IPO experts don't think this was problem at all.
“The debacle was not the IPO but all the whining by speculators who didn't make money,” says Lise Buyer, who helps companies plan initial offerings. Says Jay Ritter, a finance professor at the University of Florida, “Selling something for what it's worth is the way most people think a market should work.”
For all its flaws, the Facebook debut did fulfill the chief purpose of a stock offering — to raise money for a company to pay bills, buy rivals, invest and expand. That aim is often lost amid the inflated expectations accompanying high-profile debuts.
In an initial public offering, a company sells shares to investment banks at what's called an IPO price. Those investment banks, called underwriters, then turn around and sell the shares to big investors who've signaled they are willing to buy at the same price. The higher this initial price, the better because it means the company can raise more money. The much-anticipated pops on the first day of trading are mostly relevant to the big investors, not the company, since it has already pocketed the cash.
In fact, a big opening-day pop can suggest the company got rooked and could have set the IPO price higher and raked in more money.
Last year, several Internet IPOs soared 50 percent or more on their first days, recalling the excitement of dot-com offerings more than a decade ago. Shares of the online professional network LinkedIn, for instance, doubled in value on the first day.
“Some of the pops were excessive,” says Ann Sherman, a DePaul University finance professor who feared another “IPO bubble” was brewing. Though disappointing to many, the flat Facebook debut came as a relief to her.
Whether Facebook blew it by committing the opposite sin — overpricing — is another issue. The stock closed Friday at $31.91, down 16 percent from its IPO price last week.
There are good reasons for pricing an IPO stock so it's almost assured a small first-day rise of, say, 10 percent or 15 percent. Companies going public tend to be young, small and risky. A “guaranteed” profit helps entice big mutual funds, hedge funds and other big traders to take a chance. Walloping those big first investors with losses on the first day can make them less likely to buy when a company needs to raise cash by selling stock again in a secondary offering.