In the week following Facebook’s IPO, it gradually became clear what had happened:In the middle of the IPO roadshow, the company told analysts at the IPO underwriters to cut their estimates for Facebook’s Q2 and full-year performance because the second quarter was going badly.
The analysts then verbally relayed this information to big institutional investors, who were understandably spooked by it.
Meanwhile, small investors, to the extent they noticed, only heard about a vague new sentence on page 57 of Facebook’s IPO prospectus saying that the trend in which Facebook’s user growth was growing faster than revenue was continuing.
Facebook and Morgan Stanley are now arguing in the lawsuits that this disclosure was exactly the same as the information the big investors got. It wasn’t. The vague reference to user trends and revenue trends added to the prospectus is entirely different than a highly specific warning from the company that 2012 revenue estimates should be cut from $5.1 billion to $4.8 billion, which is what analysts and big investors got.
The estimate cut, combined with the company’s decision to 1) increase the size of the offering, and 2) increase the price range for the stock, scared many institutional investors.
For example, according to a new article by Monica Langley, Anupreeta Das, and Aaron Luchetti in the Wall Street Journal, one of the smartest big investors–Capital Research–told Morgan Stanley the new price was “ridiculous” and slashed the size of its order.
Other big institutions did the same thing, and this reduced the amount of institutional demand for Facebook stock.
That led the underwriters to turn to other buyers to place the stock.
Enter the clueless individuals who hadn’t heard about the lousy quarter and were blindly placing orders hoping to cash in on a huge first-day pop.
These folks deserve sympathy for not knowing about the estimate cut. That was important information, and the SEC rules that encourage underwriters to whisper this information to big investors and withhold it from small investors need to be changed. These individuals do not, however, deserve sympathy for not getting the free money they thought they were going to get. They speculated, and they lost. Welcome to the stock market.
The Wall Street Journal tells the story of an investor in Atlanta who didn’t expect to be able to get any Facebook stock getting an 11th hour call from his broker saying he should place an order.
(The timing of this call should have been the tipoff. When a broker calls you to say they can get you into a hot deal, the smart response is generally to put down the phone and run away screaming.)
In the broker’s defence, he didn’t know about the lousy Facebook quarter, either. Because his firm hadn’t told him about it.
Anyway, the investor placed an order and got 800 shares.
If he was still holding them a week later, he was probably wishing he had never heard of his broker.
What’s the bottom line here?
- The IPO rules need to be changed. The idea that analysts can whisper company guidance to big investors without telling small investors is ridiculous.
- Big investors and small investors did NOT get the same information about Facebook, despite what the company and Morgan Stanley say. A company-initiated estimate cut is much more concrete and important information than a vague reference to user growth continuing to exceed revenue growth.
- Small investors will always be at a disadvantage to big investors, and it’s time they understood that.
- There’s no free lunch on Wall Street, and anyone who chooses to speculate should man up and accept the risks.