Thursday, November 1, 2012

IPO Underwriters Support of Facebook Analysis

Bloomberg reports that the underwriters spent $66 million supporting the Facebook IPO in the immediate aftermarket.

It also reports that this was about 40% of the underwriting commissions and the economists making the reports opine that the the underwriters' concerns about reputation may have outweighed their short run profit motive.

Sounds good until we realize that the money spent is only about 4% of the stock offered. With the benefit of hindsight, this is clearly not enough stock to support an overpriced IPO where all the underwriters sold into all the demand they could find, not leaving any demand for the aftermarket.


Chart courtesy of Stockcharts.com


We don't like to second guess the traders who found themselves with the task of estimating where this over-hyped stock would trade with the goal of making money while supporting the stock in a market where everything seemed to go into chaos. The computer systems went into shock, the company was selectively releasing adverse information, customers were cancelling orders right and left when they were stuffed with more stock than they thought they would get after asking for more than they really wanted, and the media was hysterical. For all anyone knew, the stock could have gone to a wild premium.

However, we can all note that underwriters need to support IPOs. Stocks often come at a premium, flippers and shorts can start a landslide, and the sales effort made to place the stock only goes so far.

We can all see that the underwriter should oversell the issue with the idea of calling up stock from its Green Shoe if it has to. I have participated in deals where we went short 20% of the stock against indications that the aftermarket would be sloppy and deals where we shorted nothing.

It is important to note that estimating demand in IPO aftermarket is not a science, unless you think playing roulette is a science.  

Be that as it may, underwriters know that they need to support the aftermarket and to do that they often need to oversell the deal and come in short. The trading department simply hopes that what it may lose on this short can be made up by profits on the heavy volume that occurs.