Why Facebook shares could fall below $38

It has been a whirlwind week for Facebook. The company went public in a much-hyped IPO on Friday and founder Mark Zuckerberg got married to long-time girlfriend Priscillia Chan on Saturday in a surprise ceremony.

But even Zuckerberg’s wedding is not enough to drive attention away from the IPO which fizzled out a Nasdaq on the opening day.Facebook on Friday sold 421 million shares of stock in a deal that valued the company at more than $100 billion. But investors, expecting a first-day pop in price, instead saw it close just 0.6 percent above the IPO price at $38.23. The stock did rise to a high of $42, but the hype didn’t last and soon the underwriter banks had to step in to ensure that the stock didn’t go below the $38 price that was offered.

According Andrew Barry at the financial magazine Barrons, Facebook’s stock could fall below $38. He writes that_Yet “oversubscribed” deals aren’t always winners. Many institutional investors seek allocations of supposedly hot IPOs because they want to make money, not because they want to own the stocks. If the deals don’t trade well initially, institutions often sell quickly to lock in whatever profits they can._

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The big question that is being raised after the fizzled IPO is whether the banks will continue to support the stock. Now that Facebook will begin trading, it will face a lot of questions from investors, especially regarding the ability to raise more revenues via advertising. GM motors recently announced that it would stop advertising on Facebook as the ads weren’t useful and had little impact.

Facebook will have a hard time in the coming week if lead underwriter Morgan Stanley stops supporting the stock and managers lower down in the IPO book who were hoping for an early surge decide to get out before going underwater.

But the bank will not support the stock indefinitely, analysts said, and once that firepower is gone, funds that received IPO stock looking for a bounce may decide to bail as well.

Lead underwriters in a stock essentially “short” the stock through what is known as an “over-allotment” of shares - they sell shares to the market that they do not own. If the stock has trouble, which Facebook did, the underwriter supports it by then buying more stock at the IPO price.

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Had Morgan Stanley bought all of the shares traded around $38 in the final 20 minutes of the day, it would have spent nearly $2 billion. The “green shoe” overallotment, which can be used to support Facebook’s stock, is 63 million shares. At $38 per share, that amounts to $2.4 billion in firepower.

In an IPO where the stock rises significantly, the green shoe is typically exercised in the days after the debut and the company raises that additional amount. If Morgan Stanley shorted the full amount and bought shares on the open market to support the price, Facebook will not raise the extra $2.4 billion from the IPO.

“Right now you have one big buyer, Morgan Stanley,” said a former chief operating officer for Bear Stearns, who dealt with IPOs on the investment bank’s syndicate allocation committee, but asked not to be named as he did not want to talk publicly about the issue.

“That’s what people are trying to figure out, how much of the shoe is left,” he said. “In most deals, on the Friday that would be it; come Monday, it would be all bets are off, by Tuesday for sure.”

In addition, with the stock market in correction mode as investors fret about Europe’s ongoing debt crisis and the outlook for global growth, the environment for a new stock is not ideal.

That could mean the stock’s fate will depend on the strength of the IPO anchor orders - the big clients at the top of the IPO book, who see Facebook as a core holding - as well as a host of retail clients who are less likely to sell their shares quickly and may even be enticed to buy more.

Perfectly Priced?

In the end, Friday’s action suggests the IPO was truly priced to perfection. The company increased the amount of shares being offered last week and boosted the original selling price. Brokers at a number of broker-dealers told Reuters their clients were getting as much, if not more, than they expected.

That is what disappointed those expecting a 10 percent to 30 percent pop in the shares - rather than seeing the stock fall back to its IPO price shortly after opening.

“A Herculean effort by the underwriters, I would call it,” said Jeff Matthews of hedge fund firm Ram Partners. “How could it be a hot deal if all the usual mutual fund suspects already own some going into the IPO?” he added.

The classic move by an underwriter to stop an IPO from “breaking issue” worked, if only barely.

Given the technical issues that plagued Nasdaq, with the stock opening about 30 minutes late and delays in receiving order confirmations continuing throughout the session, it is also hard to know how much Friday’s action reflected reality.

One RBC broker said that with hindsight he was grateful that he was allocated just 500 of the 20,000 shares he requested.

Others had similar relief. Said John Lane, founder of Lane Capital Markets, a small broker-dealer in Fairfield, Conn, that has managed about 40 initial public offerings: “Many retail and institutional buyers were floored at how much stock they got.”

Lane said he spoke with a hedge fund manager and a mutual fund manager who sent buy indications to more than a dozen brokerages on the theory that they would get a fraction of what they desired. “One got filled everywhere, and the other more than he wanted. They’re both sweating right now,” said Lane, who admits he bought shares near the end of the trading day at a little over $38.04.

If shares fail to recover in coming days, retail investors who were lured back into the market by the Facebook frenzy may revert back to the caution that has slowed trading since the 2008 market crash, some brokers fear.

With inputs from Reuters