Facebook. Need we say more?

The recent initial public offering of Facebook shares has generated an incredible amount of discussion, much of it around the perceived injustice of having an IPO price at $38 per share and subsequently plummet in value. To be sure, there were irregularities that exacerbated the situation (a delayed opening, lack of timely trade confirmations, curious timing of analyst earnings reviews, etc.), but our take on things is considerably more sanguine.

It may be instructive to consider the purpose of an IPO in the first place: to raise funding for a company and/or its selling shareholders.  That means the investment banks are compensated on how much cash was rasied as a result of the IPO.  Indeed, that is true whether you are selling a house, excess items on Craigslist, or other shares you own in any other company – you strive to raise the highest amount possible by selling at the highest price possible.  Measured on that criterion, the Facebook IPO was a smashing success, raising over $16 billion for Facebook and its shareholders. The fact that the price of Facebook shares have dropped from the initial value of $38 only goes to prove just how great the underwriters did at raising the most dollars for their client.

Notice how the underwriters are not as concerned with two other items: 1) the investor who buys shares after the IPO, and 2) the price of the shares after the IPO.  True, an underwriter whose IPOs consistently drop in value right from the get-go will have a hard time selling shares to the institutional investment community in the future, but that concern is secondary to its primary task.  If retail investors in Facebook are disappointed in the price of shares after they bought them, it is probably worth revisiting the basic economic tenets of a buy/sell transaction in the stock market: a buyer makes a purchase convinced that the shares will go up in price, and said person buys them from another selling the shares because they have a similar conviction that the share price will drop.  Someone will be wrong.

Looking at Facebook IPO, those sellers were insiders: folks with years of experience and information about Facebook.  Who were the buyers after the IPO? Let’s just call them” people without that information.”  Yes, there was a 171-page offering document available for investors to gain more information about Facebook.  Did any of the secondary buyers read that? Doubtful. In other words, we had informed, institutional insiders selling shares to uniformed retail clients.  Could it really have gone any other way?

We don’t buy shares in IPOs of any ilk (let alone ones so eagerly-anticipated) precisely because the economics of the basic transaction tend to be clouded with the emotion and hubris of the Big Event.  Do we miss out on the one-day “pop” of those IPOs that go “well” in the eyes of the press? You bet we do.  But we will also miss the heartburn of the next “Facebook”  – and, trust us, “Facebook” will be the moniker of disappointing IPOs for a generation to come.