Facebook IPO: Cautionary tale for individual investors

 

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On the eve of Facebook's highly touted initial public offering two weeks ago, Murli Gupta, a math professor at George Washington University, snared 50 shares of the social networker's stock from E-Trade at the $38 offering price. He had visions of a 1990s-style first-day price pop. And wouldn't rule out a spike to $60 a share.

"I got into this IPO to try to make money," says Gupta, 65, admitting that the hype put him in a buying mood despite reservations about Facebook's ability to make enough money via advertising to match the lofty expectations. "I was hoping it would climb up high like some of the other hot IPOs, like Red Hat (which nearly tripled on its first day in August 1999) or Google (which jumped 18% in 2004)."

But the trade didn't pan out as planned. After a short-lived 18% surge, the stock closed up less than 1% on its first day and has stumbled since. As a result, Gupta and countless other retail investors — who were allotted an unprecedented 25% of Facebook IPO shares — again found themselves on the losing side of a Wall-Street-hyped investment gone bad.

In its first nine trading days, the stock has woefully underperformed, and its reputation has been tainted by controversy and dashed expectations. It closed Thursday up $1.41 at $29.60. That's 22% below its offering price and 34% below its first-day peak of $45.

Facebook shares have been hurt by a first-day trading glitch, complaints of too many shares offered at too high a price, and lawsuits alleging that the Nasdaq Stock Market botched things and that deal underwriters failed to share lowered earnings forecasts with mom-and-pop investors before the IPO.

The IPO's black eye has translated into red ink and frustration for investors like Gupta, many of whom have already given up on the stock. Gupta, after hoping for a rebound that never materialized, sold his Facebook shares Thursday morning.

"The last straw? Another dollar down (in the morning), with no hope of a positive correction," Gupta told USA TODAY seconds after he hit the sell button. His loss after dumping his 50 shares at $27.05: $547.50.

Early warning signs

Cracks in the Facebook story started to emerge in the days leading up to the first day of trading on Friday, May 18.

In a May 9 regulatory filing, Facebook warned that future revenue would be hurt by a dearth of advertising on handheld devices, which its users were increasingly using to access the site. A major advertiser also questioned the effectiveness of Facebook ads, undermining the thesis behind its main source of income: ad dollars.

The night before trading commenced, the company and underwriters said IPO shares would price at $38, the high point of an upwardly revised range. That price valued Facebook at nearly 100 times its estimated earnings, vs. a price-earnings ratio of less than 20 for Internet search engine leader Google. Facebook also increased the number of shares it was selling by 25%, in essence flooding the market with shares.

While lead underwriter Morgan Stanley has said it handled the IPO no differently than other initial public offerings and that it was in "compliance" with all regulations, the investment bank has yet to fully defuse the blame directed at it. (Facebook can't comment publicly yet due to a 40-day quiet period imposed by regulators.)