This article analyzes the Facebook IPO and the rapid decline of the stock price from its initial offering price. One of the reasons for the decline in the stock price was that the number of shares offered was increased by 25% just prior to the IPO. There were not enough buyers to purchase the additional shares. Morgan Stanley, the chief underwriter of the IPO, was forced to step into the market and purchase shares on day one, in order to keep the stock price from falling below its offering price.
The article also provides some information that is informative about the IPO process. The underwriters allocate shares to their major customers prior to the offering. One of the hedge funds reported that it received 500,000 more shares than it anticipated. That provides some insight into the magnitude of the allocations that are available to the underwriters best customers. It is valuable to be a good customer on an investment bank. The potential to earn a large profit from an IPO, is one of the reasons why customers are loyal to investment banks. During the dot com boom, access to IPO shares was a gold mine for the best customers of the underwriters. It was not unusual for the share price to double in the first day of trading. The early investors could earn a quick profit by selling. The longer term success of the company that was taken public did not matter to the early investors. Few of the high tech start ups that were taken public survived. All of the money was made by the early investors and by the underwriters who earned large fees from the IPO.
Ordinarily 20% of the shares are allocated to firms that can sell the shares to retail investors. They allocate shares to their best customers. This is valuable for the brokerage firms. It helps to sustain the loyalty of their largest clients. The Facebook IPO was widely anticipated. The allocation to brokerage firms was increased to 25% for the Facebook IPO. There were more shares available to retail investors than they were willing to purchase.
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