Congratulations to Facebook’s underwriters, you got it exactly right. There should be no disappointment.
To explain, a quick overview on IPOs. A company goes public to acquire cash that it needs to grow. It is the job of the underwriters to estimate the price that public investors are willing to pay for a share of stock on the day of the IPO. This number is very important to the company because the money that the company gets is based on this price.
For example, if the underwriters price an IPO at $10 and the stock jumps to $50 on the first day of trading, the company still only gets $10. The difference between the IPO price and the closing price $50 – $10 = $40 goes to the investors who bought at $10 early in the day and sold at $50 at the end of the day. In this case the underwriters failed. The company could have received $50 but they only got $10.
Facebook’s IPO was priced at $38 and trading finished the day at $38 and change. The underwriter’s estimate was near perfect.
So why are their so many articles saying the IPO fizzled, disappointed, and failed to live up to the hype? Well the example I described was based on economic theory, not reality. There are a couple reasons why the price normally jumps significantly during the first day. First, the banks (who employ the underwriters) have a vested interest in a stock price that skyrockets on the first day of trading. This is because the banks most valued customers are among the few who can buy at the IPO price. If the price skyrockets, these valuable customers are really happy.
Second, the company’s executives, who hire the bank, normally hold a lot of stock. Their net worth is based on the closing price, not on the IPO price. So the bank’s best customers are really happy if the underwriter’s estimate is too low (as in my example) and the company’s executives are mostly indifferent. Getting it exactly right has no upside. No one congratulates the underwriters. I think they should be recognized for a job well done. So congratulations Facebook underwriters, you nailed it!
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