Let's look at the first
day of trading in the Facebook IPO.
The stock opens in a
chaotic fashion due to tech problems. For the traders, this is not
fun as they don't know what their position is.
FB opens at $42.05, up
13%. A very respectable premium.
Chart courtesy of Stockcharts.com
If the premium is to
high, it means the bankers short changed the company, embarrassing
but not devastating because at least in such an under-priced deal, at
least money is made and the stockholders love the stock. The
underwriter has a hit to increase his chances of getting the next
deal sold. The company has the money they bargained for, just not as
much as they might have gotten.
If there is no premium
and the stock goes to a discount, it means the bankers screwed up big
time. The company gets a black eye as it starts off its relationship
with all of its public investors sore about their loss. In my humble
opinion, much better to give them a profit.
In the case of FB, in my
opinion, the deal was too high priced. We know this because by any of
the usual metrics of value, it is high priced (25 times sales and 100
times earnings and its rate of growth is slowing).
Further, we know it is
high priced because the deal closed the first day near the offering
price.
Now I don't recommend
shorting stocks unless they are “air bubbles.” An air bubble is a
company that has no earnings, no assets and no hope of living up to
its fraudulent hype. This is not Facebook by any means, but FB is
still overpriced by the standard measures of value.
When the stock closes on
the bid, this means that the underwriters are now eating stock in
large amounts that they may very well have a loss on – if they did
not oversell the deal and go short.
It would take a brave
underwriter to go short this deal as it has had so much hype. We will
never know the underwriters' actual position, but in this case we
presume that these firms, the strongest underwriters on Wall Street,
have large institutions that they can sell stock to if they have to
take stock off the market to support FB.
Underwriters go short as
much as 10% or more of the deal as it enables them to support the
stock. The exact amount of the short, if any, is a matter of
professional judgment arrived at by consultation between the
investment bankers in the syndicate or underwriting department and
the trading desk's new issue market maker. Underwriters generally
have no objection to covering some of this short at a small loss, by
covering the short at a premium to the issue price. Their reputation
depends on healthy trading in the aftermarket.
If they are short and the
stock goes to a huge premium, they are protected by their “green
shoe,” an option they have to buy usually about 10% more of the
issue. (We promise to do an article on the strategic aspects of green
shoes in the future, stay tuned.) In essence, their short position is
covered by a call option at the issue price.
Where does FB go from
here? We expect that the shorts may try smashing the syndicate bid
and seeing if they can panic the sellers. We also expect that the
underwriters will have plenty of buying power to thwart these efforts
unless they are being stuffed too hard and too fast with stock.
Despite the fact that the shorts have a ton of money to play with
from their big successes in the last few years, we expect that the
shorts will fail as they are going against all the big houses on Wall
Street. However, we also do not believe that seeing the stock hit the
offering price at the close of the first day will put courage in the
hearts and wallets of any buyers. However, after $23 billion of stock
trading in the first day, hopefully many of the flippers and the weak
sisters are out and the long term players are mostly in. If that is
the case, the syndicate won't have to eat too much stock. At these
prices, I do not envy them their bids.
This leaves the stock in
a position where it is not likely to go up for at least a while, and
not likely to go down much either, but it will be under pressure for
a few days. We would expect the battle to continue in a relatively
small range. It is clear that there is a lot of stock for sale at the
upper end of today's trading range. Facebook's high Friday is not a
price not likely to be seen fror some time.
Some are saying that
today was a good day for FB; don't believe it. As an underwriter you
certainly don't want the stock to slam against the issue price on the
first day. The ideal for the underwriters would be stability in the
$40 to $42 area, but it closed at $38.23.
Take a look at this
pattern of support in Zynga. Zynga had the same lead underwriter. As
a matter of fact, I believe that this underwriter's success with
Zynga helped it land Facebook.
Chart courtesy of
Stockcharts.com
Zynga's offering price
was $10. Based on our analysis of the company, Zynga was overpriced.
We felt that the business model was flawed because it depended on
keeping abreast of a fad business. It is very hard to do this and it
seems inevitable that sooner or later even the best managers can make
a wrong turn. We privately joked about the fact that Zynga's mascot
was a dog. The stock had substantial excitement. The stock hits the
market in December 2011 and on the first day, opens at 11, nice
premium, but then gets slammed to $9, and the underwriters managed to
get price back to about $9.5 by the end of the first day. The stock
traded down to $8 from selling pressure. Much of the stock wound up
in the hands of a relatively few, large institutional holders. The
underwriters fought back, bringing the stock to over $15, but then
they apparently pulled the plug after about four months, and the
stock loses almost half its price, trading down to $8 or $9. With the
lame performance of FB, Zynga drops over a point today. Was this
selling to create cash to buy FB? Could be, but for certain it does
not look good for Zynga bulls today.
Facebook will probably
not be too dissimilar. FB is also very strongly hyped and highly
priced. To a lesser extent, the FB business model depends on staying
ahead of consumers who can be very fickle. (if you don't believe me,
ask MySpace.) FB seems to also be under pressure and we expect the
underwriters to be supporting the market. Eventually, we believe that
the stock will not hold the offering price, though it may outgrow its
high price over the long term. In the first few months we would be
surprised to see much of a drop because of underwriter support. This
is the deal of the decade and a lot of pride is on the line. The hard
part would be to find a sell point, but there are I am sure many
other better shorts you can go after. Facebook is a real company with
a lot of strengths.
The Excitement
Silicon Valley is wildly
excited about the huge money raise of the Facebook initial public
offering. They may find that Facebook is the peak of the social
media/tech excitement and all this money going into one stock may
leave less lying around for the rest of these companies. Being a
trader means not being carried away by excitement. I am also very
excited about these new companies and their rapid growth. It is the
fulfillment of a dream I had ten years ago, to create “Rocket
Rides.”
However, as a trader, I
know to sell into the type of excitement that FB has and buy value
when nobody else wants it. We are looking for something very
under-priced that will rapidly go over-priced. We have stocks we
hope will fit this model, but FB is not one of them. Even if FB
reaches $100 in five years, as some bulls predict, that is only a
250% gain in five years. Why not try to do it in one year with
something under-priced that has less risk?
Disclaimer
This is not investment advice or a recommendation of any kind, merely educational commentary and I have no position in these stocks.
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