Facebook: Who's To Blame?

May.22.12 | About: Facebook (FB)

Tuesday morning, the beating in shares of Facebook (NASDAQ:FB) continued, with shares touching a low under $31 before rebounding to about $33 as I wrote this article. All eyes have been on this story for the past week, and as I've said recently, it is amazing to see how much attention this is getting. As the stock goes lower and lower, frustrations are building both on Wall Street and Main Street over what seems like a botched IPO. The question is, who's to blame? I'll give my opinions and dole out some percentages below.

Nasdaq OMX Group (NASDAQ:NDAQ) - 35%:

You have to give the exchange a fair amount of blame for this issue. There were obvious issues building on Friday morning, so why bother even opening the stock? We were supposed to get it open at 11 a.m., that was delayed by half an hour. Once trading began, there were many trading issues, with many participants not receiving confirmations for hours, if they did at all. The Nasdaq is planning on spending $13 million to make amends for bad trades.

Even with months to prepare, the exchange should have realized ahead of time that it wasn't ready for this thing to start trading. Strangely enough, the company's annual meeting of shareholders is this week, putting more emphasis on the name. The exchange has a black eye, which could have easily been avoided.

The Underwriters - 25%:

Those leading the deal, including Morgan Stanley (NYSE:MS), have to provide a best effort to make sure this deal works out. They obviously did not. If the underwriters were truly taking down their internal Facebook estimates, they should not have been raising the price of the deal and allowing more shares to be sold.

Several months ago, we asked if LinkedIn (NYSE:LNKD) was priced too low, when the stock, priced at $45, opened around $80 and rallied at one point to more than $120 on its first day. While it does seem as if they priced LinkedIn a bit too low, they wanted to make sure that it would have some sort of pop the first day. It is obvious that the underwriters did not have the same intentions with Facebook, or they would have priced the company in the original range. Perhaps they overestimated demand. My personal opinion is that a $30 offering price would have worked quite well. Those selling still would still have made a killing, and a first day pop would have occurred.

Questions are now being asked about what the underwriters did once the name started trading. Was Morgan Stanley buying up a ton of shares at $38 to keep it above the offering price, or were they shorting the stock heavily, potentially making a killing over the past few days? We'll get a better idea of how the underwriters looked at this company when they can start publishing their reports on the name in the next month or so.

Facebook - 20%:

Yes, you do have to give some blame to the company here. They are the ones going public and selling shares. The company probably decided to sell too many shares, which led to a couple of problems. First, there was too much supply out there, and actual demand (not including those who were trying to flip shares the first day) was much lower than expected. Secondly, a number of investors seemed to be concerned by the extra insider selling when the deal size was increased late in the game.

From all reports, Facebook really didn't need a ton of cash from this offering. It was basically a way to get the insiders out at a nice level. Well, they certainly did that. Anyone who sold at $38 looks like a genius now that we are at $32. As the phenomenon wears off, Facebook will eventually trade off fundamentals, but that might take some time.

It might have been a better idea if the company had announced plans to go public a few months earlier, giving both the exchange more time to prepare, and not creating a rush to get this done before the summer. I'll cover part of that in the next section.

The calendar - 10%:

This might seem rather strange, but I'll make my argument. This weekend is Memorial Day weekend, the unofficial start of summer. They wanted to get this IPO out not just before the holiday weekend, but the week before that. You would not have seen this go public this Friday (the 25th).

There seemed to be a rush to get this thing going, and it did make sense to get it done sooner rather than later. Having Facebook go public in the middle of the summer wouldn't have been great with everyone on vacation. Trading volumes are lower, so they wanted to get this out quickly. That created a number of problems.

Investors/Traders, including myself - 5%:

Yes, I will even take some of the blame. Why? On Friday morning, when Facebook started quoting around 10:45 a.m., the stock was looking like it would open at $45. I placed a limit order at $42. As the potential opening price started creeping lower, and especially after CNBC's Gary Kaminsky noted that Facebook could trade down to the offering price of $38, I cancelled my order.

I'm sure that I wasn't the only one to cancel an order. In fact, I think we heard the media and exchange report that too many cancelled orders was one of the problems with the system. So I'll take some of the blame along with everyone else who cancelled orders. But here's the issue. I cancelled an order for 140 shares. Not exactly a large amount. For an exchange that handles billions of shares in volume, my order cancellation was just a drop in the bucket. The larger issue was the exchange's inability to handle such a complicated process.

General Motors (NYSE:GM) - 5%:

Yes, I have to give the auto maker some blame for this as well. They announced pre-IPO that they would be pulling Facebook ads, which led to multiple discussions about Facebook ads showing low click through rates. Facebook is dependent on its advertising revenue, although GM's $10 million pull isn't the end of the world.

So why do I really blame the auto maker? It has to do with timing. I can't believe the company just made this decision last week. It has probably been something they have been debating for weeks, perhaps months. Why wait until a day or two before the IPO to announce this information? In my opinion, General Motors knew Facebook was going public sometime in mid-May. They could have announced this information a few weeks ago. It might have had an impact on the amount of shares offered and the analysis of the deal earlier on in the process.

Conclusion - No One Party Did This All:

Many questions are being asked after the poor performance of the Facebook IPO, and there is plenty of blame to go around. While there are a few parties that share a larger portion of the blame, no one party was the main culprit. This was a culmination of problems that just all happened to mass into a larger one.

Hopefully, there will be some important lessons learned going forward, for all parties involved. What do I mean by this? Let's look at how the involved parties can improve in the future.

Obviously, since I gave the exchange the largest share of blame, that system needs to be fixed. We've heard that they are planning on doing this. The $13 million they are dishing out will also make some parties feel better, but it's not a total solution. We could see lawsuits coming.

But the larger implication is for investors, and I'll include myself in this. There has to be a point at which you don't get sucked into the vacuum. By that, I mean just avoid the situation altogether. We saw this with the LinkedIn IPO. Shares traded well above $100 on the first day, only to drop down to the $50s within weeks. Facebook opened in the $42 to $45 range, and is now about $10 below that level. There have been plenty of losses, and that does not make investors feel comfortable, in a market where some think manipulation is rampant.

So what is my best advice? Well, it is to always do your homework, and to only trade or invest in what you know. I jokingly mentioned in a blog post yesterday that doing Facebook research doesn't involve checking your friends' status updates. I've chosen to avoid Facebook because I can't develop a valuation at which I can feel comfortable owning shares of this company. Until I can, I will only focus on stocks and companies that I know and can actively analyze on a daily basis. I don't feel comfortable investing in Facebook right now, and if you don't either, it should be avoided at all costs. The phrase "invest in what you know" is very true here.

I hope this article not only analyzed who is to blame, but examined how everyone has a role in a stock market process like this. My goal here is not to just figure out who should be blamed. I am more concerned with creating a debate about what can be done to better serve the investing public going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.