What Happened at Facebook, Anyway?

The Facebook IPO had problems, but they are not especially unique. The problem, really, is that it has been so long that we’ve had a lot of IPOs that everyone has forgotten how they work.

Way back in my investing banking days, I worked for a firm that was a dot-com bubble IPO factory. (Alas, not in health care services, the industry I covered.) I saw a lot of insanity back then, so I’m not seeing anything about the Facebook deal that looks especially nefarious. Here’s my take:

• A good IPO should not pop after the deal comes public. If the demand is so great that the shares increase in price, then the company lost money – you have a direct transfer of wealth from the business to investors. The investment bankers, who were hired by the company, did not do their job if that happens.
• That being said, most investment banks also have large institutional customer bases that they want to keep happy by giving them a quick profit on a hot deal. In the dot com days, the people who got the shares of the hot IPOs were often venture capitalists or executives of private companies that the firm hoped would use them in the future. There was a big scandal and a global research settlement that emerged from this at the tail end of the dot com bubble, so bankers are much more careful to avoid this.
• Before the dot com bubble, IPOs were often very hard to get done, and it was not unusual for the underwriters to have to cut the price before the deal or for the stock price to fall on the first day of trading. When I worked for a mutual fund company, the fund managers often waited until after the IPO to buy shares.
• One investment bank. W.R. Hambrecht, structures its stock offerings as an auction, to find the market-clearing price for both the company and the investors. Most of the IPOs they have done have been small, but they worked on a few biggies like Morningstar and Google. They offer such an elegant solution to the problem of pricing IPOs that I don’t understand why they aren’t more popular.
• The analysts at the investment banks are not to publish estimates before an IPO because legally, all information about the company has to be in the prospectus. Estimates are distributed informally, so the idea that some investors had different estimates than others is not exactly a shocker. Really, no one is supposed to have estimates, and certainly nothing in writing.
• The prospectus isn’t final until after the shares start trading, and the information in it can change. Sometimes, what is in the final is very, very different from what was in the reds (which is the slang term for a preliminary prospectus because of the red print warning that the information is not complete and is subject to change.)

Many people put in for the Facebook IPO assuming that the price would pop on the first day and they could flip the shares, but that was a faulty assumption. And, no one is supposed to publish estimates before the deal, so it’s not like the different estimates floating around before the deal is an especially strange deal. From what I can tell, no laws were broken.

That doesn’t mean the IPO process isn’t broken, though. That’s the bottom line.