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.




 

Trading IPO Lock-Up Expirations

Initial Public Offerings have lock-ups. In a lock-up, existing holders of the IPO stock, people who own stock at the time of the new issue, agree not to sell for a certain period of time. 

This allows the underwriter to support the stock without having to worry about the existing holders dumping on his efforts. 

To give you an example of what happens when there is no lock-up, I recall one deal about 1984 that was a roll-up of existing oil and gas partnerships. The promoters offered a large number of owners of interests in oil and gas limited partnerships the chance to swap them for stock at a valuation of $5 per share. This stock was the subject of a registration statement, giving these investors stock in a soon to be public company.

When the issue hit the market, it may have had a print, a trade at $5 but the efforts to support the stock soon collapsed as all the holders of the stock sought to dump it for cash. The stock was soon at $1.50, never to see $5 ever again.

Underwriters soon learn that their performance largely is graded on the short term price of the stock. After six months or so, they are off the hook. The question for the underwriter is will the stock go to a premium in the immediate aftermarket. 

True., the underwriter has warrants lasting usually two years, allowing him to buy often one share for every ten he sold at the issue price, but most of these are worthless two years later. The ones that are exercised often have huge rewards. In other works, underwriter warrants are a something like a lottery ticket -- more likely worthless but a big payoff if they are not. 

As a trader, you can be certain that when the lock-ups expire, the supply of stock will increase. As most new issues are issued at a relatively high price because of promotion by the underwriters, and that promotion is long since over by the time of the lock-up expiration, you can be sure that a lock-up expiration is going to find a soft market. 

This is not to say that the stock will collapse, but as a trader, you do not want to be long into a lock-up expiration. 

If you are looking for a good short, one with a huge drop in price, you probably would not be looking at lock-ups for IPOs, as they do not mean huge drops in price, but they do mean a soft market. 

As an IPO market maker, you can be sure I would know the dates of all lockups, and  would never enter a lock-up expiration make sure I had a nice short position.     

We now have a chance to test these ideas, as Facebook, a stock that has had a disastrous aftermarket, now faces expiring lock-ups. 

                                           Chart courtesy of Stockcharts.com 

I read that 230 million employee shares will soon be free. -- 11% of the company's existing 2.1 billion shares outstanding.

Another tidal wave of stock, hits November 14, when 777 million shares are freed up. In a period of a few weeks, shares equal to almost half of Facebook's current shares outstanding can hit the market. 

The only reason not to make a knee-jerk decision to short this stock is that it is down into "fallen angel" territory already. 

You have to wonder what the underwriters and the company were thinking when they structured all this, including soaking up all available demand to begin with.   

It is not a question of how loyal or how enthusiastic about the future these shareholders are. People love money and many of these shareholders have huge fortunes awaiting them they will want to enjoy now.   

Just the amount of money needed to soak up all this stock almost guarantees another soft market. How many buyers are left for this stock?   

Another form of lock-up that you should not overlook is the availability of stock to be sold pursuant to Rule 144.  You may recall that that holding period for 144 is six months. Also recall that the insiders ("affiliates"), those who are key officers and directors and 10% shareholders, can sell 1% per quarter of the outstanding stock of that class, or if the class is listed on a stock exchange or quoted on Nasdaq, the greater of 1% or the average reported weekly trading volume during the four weeks preceding the filing a notice of sale on Form 144.

Always look for new supply and new demand in trading IPOs.  Your job is prediction.

Why Facebook has declined

There are several factors but they basically all stem from the desire of the company to maximize the proceeds from the offering to the detriment of investors.

In a typical successful offering, the company and the underwriters leave a little on the table for the investors, which is to say the deliberately underprice the offering, say by 10%, to give the investors who buy at the offering price a small premium in the aftermarket.

This helps the underwriters sell the deal and keeps the investors happy with the company. 

Facebook was the deal of the year and sought after by many investors. Many investors sought stock in the deal just for the prestige of saying they participated in the offering.

The company took advantage of this by selling as much stock as possible, soaking up all of this excessive demand, leaving nothing on the table. 

Thus, no one was left to buy in the aftermarket. 

This was made worse when the company increased the amount of stock offered at the last minute and also started revealing bad news about the business.

Many buyers  in the offering thought they would not get as much stock as they asked for so they asked for more than they actually wanted. When their entire allocation was filled, they knew the demand was soft and so they sold and they also sold because they had then more stock than they really wanted.

The shorts, seeing this, smelled blood in the water and did a bear raid, dumping stock to push the price down.

This created down side momentum.

With this price drop, people started taking a critical look at the company. The shorts also encouraged this surge in bad opinions about the company. 

In fact, Facebook's business model has flaws. One thing that is not generally realized is that professional Internet marketers create many accounts. Facebook touts as its most important metric that they have one billion users. If however, an Internet market creates 100 accounts, the actual user count is much lower. 

In any event, the price decline is an example of what I call pendulum theory. The more you pull a pendulum one way, the more it swings the other. And so it is with stocks. The more they are overpriced, the more they will tend to swing to underpriced.

 Facebook was an easy short as it was the subject of wild mass public enthusiasm. Such stocks always are overpriced. 

The sheer size of the offering also hurt. Facebook's large offering soaked up much of the money that would have been allocated to such stocks. As they say, it took all the air out of the sails. 

Short Selling IPOs

As a former market maker in IPOs, it is my humble opinion that there are two types of short selling in IPOs.

First, the tactical short, whereby you take advantage of a temporary overpricing of the stock. This can be day trading -- in and out in as little as 15 minutes.

If you are an experienced trader, this should be second nature and we will not dwell on it.

However, the second type of short selling in initial public offerings has been very lucrative lately. This is the position short, whereby you are take a large position and hold it.

To do this, you have to be convince that the IPO is wildly overpriced. Usually it will be overpriced for one of two reasons: (1) the underwriters have succumbed to the company's demands that they sell the stock at some wild overvaluation, or (2) the public demand has reached a frenzy and the public is overpricing the stock.

The advantage to the short sellers in selling initial public offering is that the company and the underwriters will have whipped up demand for the issue, created a market to sell into.

The danger to the short is if the underwriter is able to support the issue and move it up. If the underwriter opens the stock at a modest premium to the offering price, and then the short starts selling only to find the stock moving up, the short has lost money. It is a matter of judging the market, and that comes with experience.

Take a look at Zynga:

I regarded Zynga as an overpriced dog at the issue price. When you compared it to the other social underwritings based on users, revenue, etc. it was clearly overpriced.

The underwriter did a great job supporting the stock and a brilliant research report helped push the stock up from the offering price of $10 to a high nearly 50% higher.

Alas for Zynga, the flaws in the business caught up with it, no doubt publicized by those with a short interest in the stock. The stock is now so low, it is a fallen angel, down to about 25% of the issue price.

It is not uncommon to see an underwriting fall maybe 50%, as most of them are over promoted to begin with, but to fall to 25%, that is a very sad comment on the company, the underwriting and on the investors who paid up for it.

My guess is that the stock may recover from this low price, but this is still not a stock I would look at buying.

Facebook was a screaming short -- too much hype, too little reality at that price. My spreadsheet also showed massive overvaluation compared with other such stocks. I told a social media client if he wanted to do an underwriting, he had to go public before Facebook hit the market as FB would take all the air out of the market -- all the money would go into Facebook.

The result was worse than I thought due to the company stuffing the market with all the stock that was demanded and leaving the market without any buyers in the aftermarket.

 There were a ton of shorts and reportedly it was hard to borrow the stock so you could short it.

As you can see, this was a gratifying experience for the shorts.

With any IPO short, when the stock falls to something like 50% of the offering price, it is time to look for the exits and cover.

Alternatively, you can just play trend lines to lead you to the best return on investment per unit time.

All of this starts with a spreadsheet analyzing pricing, and I will show you one shortly in a new post, with complete explanation of how it works and how to use it.

How Facebook IPO became face plant IPO

Facebook would be the poster child for how not to do a public offering,

                                               Chart courtesy of Stockcharts.com

 except for the fact that Zynga holds that title:

                                               Chart courtesy of Stockcharts.com

So what went wrong, what are the consequences, and what to do in the future?


Hubris

With regard to Facebook and Zynga, much of the mis-perception on the part of the company comes from their buying their own story (notice I didn't say bullshit).

They believed that their tree would grow to the moon. Sorry, we are in a very competitive economy and everything regresses to the mean.


Pendulum Theory

In fact, we have "Pendulum Theory (TM)." Pendulum theory says that when you pull the pendulum further out in one direction, the more it swings back in the other.

The issue price on these IPOs was very high, and now the market price has swung very low. They are now what I call Fallen Angels.


Leaving Something on the Table

These companies tried to maximize their cash intake in their initial public offering. The tradition on Wall Street has been to leave some money on the table for the buyers so that the stock will trade at a reasonable premium. They did not do that, they greedily soaked up all the demand at a price that was pushed to the limit. Facebook actually increased the offering amount of shares at the last minute to soak up all the money on the table.

The idea of a smart underwriter is to leave buying out there to soak up the flippers and shorts and still have some demand for the deal in the aftermarket. This ensures a premium and you can call the deal a success if it holds its own for a few months.

Instead, all the demand was taken by the company, making the stock vulnerable and causing the shorts to celebrate.


Disclosure

We read now that Facebook was trying to polish its disclosure. I believe that in the offering document you tell it as ugly as you can. The purpose of the prospectus is to protect the company, not the investor. You also protect the investor by telling the harsh truth, and by putting the worst face up front, you protect the company. By hiding things, you can get into big trouble. They failed to appreciate that these deals were so hot they could have been very pessimistic and they still would have sold out.


Consequences

The consequences of this rape of the IPO buyer strategy are now evident.

We see lawsuits. Nobody sues if the stock is up or at least near the issue price. But everyone assumes fraud is the price is way down.

We see employees leaving, demoralized by the decline in the value of their incentive stock and options.

We see burned institutional buyers that will be happy to tell the company and the underwriters what to do with their next stock offering -- something involving rolling the stock certificates into a conical shape and storing them elsewhere.

We see management having to defend, defend, defend and that is not good for morale or company expansion.

Was it worth it, guys?


What to Do Now

The company has to eat crow and mend fences. Buying up that low priced stock with all the cash they got would not hurt.

The underwriters have to wait for the institutions to forget and try to make it up somehow.

The IPO buyers have to look out for companies that put themselves first. The shorts will be watching for those also.

IPO Fallen Angels

Sometimes a IPO company stock falls to one-half of its initial public offering issue price in the first 6-12 months. .

Notice I am not mentioning Facebook or Zynga specifically and this is not a buy recommendation on any stock.

This may be an opportunity.

Consider, the company just got in a huge chunk of cash. They will of course spend much of this, we hope it will be spent in a manner that increases value.

Time to get out the quarterly statements and calculate the cash per share and the other valuation metrics.

If you see signs of a bottom, if the insiders are starting to buy, you might consider a trade in these "fallen angels" as the IPO premium is gone if the price is down 50% in less than one year.

This assumes the price did not crash because of some discovered fraud or other catastrophe.

These stocks are worth a look.

Consider also the short interest that may or may not be there.

Do not buy any stock still in a declining trend -- avoid these falling knives and look for technical signs of a solid bottom on the chart.

Facebook IPO -- Now the Story Comes Out

Every time you trade a stock, you only learn why the move is happening when it is too late to take action.

As a trader, you have to read straws in the wind. The stock is down when it should be up, get out. You will find out later why that was the right thing to do.

Here is a great link to what actually happened (apparently): http://www.businessinsider.com/exclusive-heres-the-inside-story-of-what-happened-on-the-facebook-ipo-2012-5?nr_email_referer=1&utm_source=Triggermail&utm_medium=email&utm_term=Business%20Insider%20Select&utm_campaign=Business%20Insider%20Select%202012-05-23

That is history, we deal in the future. What next for the FB IPO?

Here is the chart.

Chart courtesy of Stockcharts.com

We see some buying come in, the stock may have held for the time being. Note the lower volume. Big short interest. Perhaps the stock will hold here but even if it does, we don't see a clear sign of the kind of up potential that would bring a good trade.

Neither do we see a short trade, even though some say Facebook is a $20 number. If nothing else, there is too much company on the short side.

The bears are all over the media, but that is now, today. I think the bulls will be formulating a counter attack but I doubt it will take the stock to new highs.

It pays to wait for the right trade.

Facebook IPO Day Three -- Short Selling vs. Underwriters

Facebook Day Three

Facebook gets more interesting.

The stock opens below 33 and closes at 31.

There are reports that the underwriters reduced their revenue projections for Facebook and that this information went to some and not others. This could bring serious legal complications.

More importantly Finra says 30 million shares of Facebook were sold short in the first two days.

Chart courtesy of Stockcharts.com

This tells us that the underwriters thought the stock had more demand than it did, and that the shorts had a field day.

Short interest is up in many other social media stocks. The shorts correctly saw Facebook as a bubble and have profited nicely.  They have a big short in Zynga, but unless they know something I don't know, they may want to look to take some of that back and lock in profits.  Wall Street is one place where it does not pay to be too greedy.

My opinion, the FB underwriters, seeing the volume drying up, could try to make a stand at 31. I would not look to buy the stock until it makes a clear bottom. Neither would I try to short it at $7 below the offering price.   

Facebook - day two

On its second day of trading, Facebook became a short seller's dream.

Anyone who went short on day one, betting that the syndicate couldn't hold the bid, won nicely.

Here is the chart:

Facebook broke its offering price on the open with a gap of over a point -- a sign of major weakness -- hitting a low for the day of $33 and closing not much better.

On the whole, a big black eye for the underwriters, the company and the all social media  IPOs.

Not only has Facebook soaked up a huge amount of IPO money, it has caused a portion of that money to be lost. So the IPO market is losing ammunition and I believe this will cause it to lose courage as well. If you didn't get your initial public offering out before Facebook hit, you will find that you are running uphill now.

The only sign of hope is that the volume was much lower today so hopefully for the underwriters, the flippers are being cleaned up and the shorts will not be so eager to take new positions.

I would not be following this stock until it shows signs of making a bottom -- something I would not expect for a while -- or unless I had a position.

You can expect the shorts to keep pummeling the media with articles saying Facebook is only worth $20 per share and the longs to be looking for any straw they can to support their stock.

Facebook IPO Trading -- First Day

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.

Facebook IPO -- the battle begins

In any stock where the bulls and the bears are battling fiercely for supremacy, there will be a media battle.

Sometimes there is a security analyst battle as well.

Just Google the news on Facebook and see it in action. For example, it is reported recently that most users do not trust Facebook, 57% never click on ads, etc, etc. etc.

Why didn't this come out before? There was no economic incentive.

While one article compares Facebook to Google unfavorably for Facebook, another says Facebook is better than Google.

And so on.

Who do we believe?

Us!

We make a spreadsheet of valuations based on key metrics, revenues, profits, growth, and in this case number of users. This spreadsheet compares the deal we are looking at to those already trading.

Having done the quantitative analysis, we can do the qualitative analysis, tearing into the business model, the competition, the management and whatever else we deem relevant.

We are then ready to judge for ourselves.

Will give you a list of IPO factors to look at later.

Facebook & Retail Investors

It is now reported that (1) a retail broker was added as an underwriter for Facebook, (2) Facebook's valuation is rich compared to Google.

When you see an issue like this, you can expect that the shorts will be drooling at the high valuation and public excitement because this creates a chance that the stock is overvalued.

You can expect the bulls and the bears to fight it out in the media with arguments and counter-arguments being leaked to reports and bloggers.

The underwriters have given the stock a high price based on the demand. Comparing Facebook to Google, using market cap and revenues, Facebook comes up short on value. You should always do a comparison table of new issues vs. outstanding companies if you are going to trade.

So far, we would expect the stock to trade at a premium and then as the flippers sell, the shorts may move in for the kill. We do not see institutional buying at higher prices. We do see those who bought privately taking a profit to escape the risk and weak holders buying in the aftermarket.

We expect it will trade more like Zynga which settled into the hands of a relatively few large institutions and had a huge short interest. The shorts won in the end.

When you are short a new issue, you are not looking for the company to go broke -- after all, they just won a ton of cash. Rather you want it to duck below the issue price and then if all goes well, when the lock up period ends you will see a further decline you can cover on. The insiders who sell after the lock up paid little or nothing for their stock in most cases and the price they are getting even after a decline is a big payday.

If we were trading this, and we are not, we would be looking for price spike creating a short opportunity. This is not investment advice here folks, this is how a market maker might look at the market.

Will Facebook make a long term run up? Who knows, that is for the analysts to predict.

Retail Investors in IPOs

It is reported that Facebook may allocate stock in their IPO to retail investors.

Without commenting on Facebook at all here, I would like to say a word about retail investors in IPOs.

You can divide retail investors into two camps -- the traders and the holders.

The traders are sophisticated and generally get allocations of new issues because they have active accounts. They have a short time horizon and are morel likely to flip. The problem for the underwriter is that giving IPO to these accounts rewards loyalty but the stock. The behavior of the traders is much that of any hedge fund that plays these markets. They flip.

This is perhaps why you see many new issues go to a premium and then decline. The underwriter creates enough demand to get the stock to a premium, the flippers flip and the stock gets soggy.

Can you say Zynga?

It does not help that companies try to engineer their results to be at a peak when the public offering becomes effective and then, having gathered a ton of money, they relax.

The retail buy and holder investors are not flippers, they are true believers. Now it may be that a buy and hold strategy wins in the long run, but it is a slow and sure way to wealth.

There is one circumstance where retail investors can be stampeded into selling -- the bear raid. The classic example of this would be when Vonage opened up their initial public offering to their customers who could buy over the Internet. They bought in droves, making the offering a success initially. However, the shorts saw that these retail, unsophisticated investors could easily be stampeded and they took the stock down. In classic bear raid fashion, the retail investors panicked and sold at much lower prices. The result was not pleasant for Vonage as the plaintiffs' attorneys who specialize in securities, ever eager and also smelling blood in the water, jumped into the fray with lawsuits, further aiding the short sellers.

This underscores the importance of  keeping your IPO stock price up -- hopefully by underpricing a bit it so something is left on the table for the public.  Nobody ever sued a company for a stock that went up.

Litigation also presents a risk for those looking for value in "fallen angels," those stocks that are down 50% of the issue price.

In summary, retail investors, those who buy and hold are friends of the company, unless they are stampeded out. Traders help the stock get to a premium, but then they can be a bad effect on price as they tend to sell fast. .

Facebook Over- or Under-Subscribed ?

The Facebook IPO is now in the news and there are conflicting reports about the demand for the IPO.

Some say the deal is over-subscribed, some say the public will not be able to get any stock, that even the institutions are having a hard time getting allocations, and some say investors are backing off because of concerns about the underlying growth of Facebook.

Now is a good time to say a few words about new issues being over or under-subscribed. My background as a new issue market maker and an underwriter gives me some insight into these issues in general and I will say a few words about the Facebook IPO in particular. 

First, the underwriters will always put up a show of any issue being in great demand. They know that creating at least an appearance, if not the reality, of an IPO being a hot issue, is necessary to create demand. Who wants to buy something nobody else wants? There is always the risk that the issue will go to a discount to the offering price and you will lose money. 

We know everyone wants something that is in great demand and with new issues, this is most obvious. If you can get an allocation of a new issue that is hot, it will easily go to a premium and your profit will be like not just like shooting fish in a barrel, it will be like shooting dead fish in a barrel with a shotgun. 

Only the underwriters know for sure if the issue is all sold, or if there is excess demand. Having a strong demand for an issues makes their life a dream. They need make no effort to place the stock. The people that get the allocations owe them a favor, and in the jungle of Wall Street you need this kind of good will capital to survive. 

On the other hand, having a dog on your hands is a nightmare. You have visions of your all important year end bonus dwindling. You now owe favors to anyone who takes the stock. In fact, if it declines in the aftermarket, they may hate you. They could even sue you. 

So the underwriters would love to see a rumor line that the issue is in great demand. 

A smart underwriter will not let the issue hit the market until he has sold enough, whipped up enough demand, that there will be plenty of investors left without stock who will buy in the aftermarket and make it a hot issue. 

Hopefully this demand will not be from flippers who will toss the stock back on the market immediately, crushing the bid. 

As to how much excess demand is needed, anyone can only guess. It will vary from issue to issue, market condition to market condition and stock to stock. This is art not science.

As underwriters are only as good as their last deal, they need not issues continually. 

Fortunately, if they  support the issue for about three months, their name will be forgotten if the stock then slides. It is enough for the stock to stay up for a decent amount of time. They need not be in there forever, but it will not hurt their ranking if the stock continues to go up. After two years, they can get a big payday from cashing in their underwriter's warrants if the stock is way up. A typical underwriter's warrant might allow the underwriter to buy 10% of what he sold at the issue price. You can therefore imagine which underwriters are happy with what issues. 

With regard to Facebook, I suspect first that is will be a very hot issue. The media coverage is enormous and that always helps. Further, getting a few shares is a prestige matter as this is the deal of the year. With this allocation you get bragging rights and proof of clout, as well as profit. Finally, the public will be in there buying in the aftermarket, you may be sure. 

However, the recent reports of the company would lead me to believe that the future for the aftermarket in the long term is clouded and I personally would not be recommending that you run and buy it in the aftermarket. Rather, if the stock goes to a very excessive premium, I would be looking at the short side, but I do not believe it will gap up that far, but I do believe it will trade at a good premium. 

Strong Disclaimer -- This is not investment advice, rather I believe you should stay out of these markets. Shark tanks like this are only for the professional. I have no position and am very unlikely to take one. I am not predicting or advising, only explaining how the game might work. Best of luck to all. 

Steps in Trading Initial Public Offerings.

The steps in trading an IPO

1. Take a look at the SEC filing before the company is effective. Make your own analysis of value.

2. Where you have a clear idea of value, and it diverges wildly from the offering price, get ready to trade.

3. Track the news and demand for the stock.

4. When the issue starts trading, follow the trading pattern of the IPOto find an entry point.

4. Put in stops and look for your exit.