The Facebook IPO: What went wrong?

Buy what you know...this is tried and true advice and one of the first rules of investing in the stock market. For many novice investors, the initial public offering (IPO) of Facebook (NSQ:FB) was seen as the perfect chance to invest in a hot technology company that you actually understand and use everyday. Nobody anticipated the fiasco that would ensue.

Back of the line
In any IPO, there is the normal advantage that early private equity investors have of cashing in on their shares during the first trading day. While this was expected to happen on Facebook’s IPO day, the huge demand for shares from institutional and retail investors was supposed to have offset any major price drops that would come from the big sell-offs.

Then there is the advantage of institutional investors, whose orders are given first priority as the shares start trading. Institutional investors are like frequent flyers – they get shuttled ahead to the front of the line and given valued customer treatment because of the high volume and frequency with which they trade.

As a retail investor, stuck in economy class, you get to follow along afterward to make your trades with the help of your investment advisor or using a direct investing website.

Technically flawed
Despite knowing they would be at the back of the queue, millions of retail investors decided to give the Facebook IPO a whirl. For many, it was their first foray into the stock market. Unfortunately, this happened to be the day when the Nasdaq stock exchange chose to have a technological meltdown.

From the moment hoodie-wearing Mark Zuckerberg virtually rang the trading bell from his office in California, the day went downhill. Where were Facebook shares? The moment everyone had been waiting for required everyone to wait, and wait some more. 

Finally, the shares appeared on the exchange and investors could start trading. And that’s when the havoc really started. Buy orders, which are supposed to be confirmed within seconds, took hours to be confirmed and many were eventually executed at the wrong price. Cancel orders went unprocessed. Sell orders were equally delayed or went missing.

When it came to the trading glitches, retail and institutional investors were all in the same class. It is estimated that total losses due to Nasdaq trading errors on May 18th were about $150-200 million.

Selective disclosure
A few days after the IPO, it emerged that some institutional investors had received private warnings that Facebook’s revenues are weakening due to ‘Friends’ using Facebook on mobile phones and thereavoiding those all-important, revenue-generating online ads. Naturally, this caused the big-gun investors to question Facebook’s value and IPO share price and upon the launch, they traded accordingly.

The stock market operates on the principle of a fair exchange between individuals with access to the same set of facts. Laws prevent companies from selectively disclosing ‘material information’ (i.e., data which could affect a company’s financial performance). Any material information has to be released public press release for any and all to access.

A class action lawsuit was filed against Facebook for hiding “unfavourable growth forecasts.” A second lawsuit was filed against Mark Zuckerberg for insider trading – claiming he personally profited not disclosing information and then selling $1 billion worth of his own shares.

The Facebook blues
“Say goodbye to the individual investor on Wall Street,” wrote celebrity investor Mark Cuban on his influential blog, regarding the Facebook IPO collapse. “Whatever positive impression they had of the IPO market and the stock market in general was just torched to the ground. When everyone you know associated with the stock market is telling you, and the media is confirming, that this could be a huge IPO that will make money for those lucky enough to get shares and the opposite happens – goodnight.”

The Wall Street Journal reported that in the two weeks following Facebook’s IPO, more than $3 billion was withdrawn from US equity mutual funds small investors.  Compare that to the week prior, when small investors added a net $311 million to US equity mutual funds.

What did we learn here?
First of all, IPOs are not for the faint of heart nor the weak of wallet. Even without technology glitches, the hype, excitement and aggressive day-trading that rushes in with a company’s IPO is not a place for beginner investors and their life savings. Leave the mob scenes to the people with riot gear. Like most things in life, you are better off starting slowly, being prudent and getting comfortable with how the market works each step of the way.

Second, assuming your buy order is executed correctly, there is no reason for a serious investor to sell their shares within the same day. Doing so is called speculating and it is a high-stakes game for experts who are adept at day-trading and market timing. So those who are disappointed that their Facebook shares did not immediately deliver massive profits are confusing investment returns with gambling wins. We don’t think investing should be a game, especially when your savings and retirement funds are at stake.

Third, buy low and sell high.  You’d be amazed how many investors panic when they see stock market drops and sell their shares for less than what they paid. Certainly there are times in life when you may need to cut your losses. In general however, selling a stock for less than you bought it for merely locks in potential losses. Most newly public companies need time to appreciate, grow and mature. We like to remember the wise words of investment guru Philip Fisher, who famously said, “If the job has been correctly done when a common stock is purchased, the time to sell it is almost never.”

Be the tortoise
It is a shame that the Facebook IPO turned out to be disappointing on many levels. However, we hope that one very high-profile, overly-hyped IPO doesn’t turn you off investing in equities for the long term.  That would be an even bigger shame, since equities are an essential component in a well-balanced portfolio and the stock market remains the most consistent vehicle in which to achieve long term capital appreciation. This is classic tortoise and hare stuff…and Facebook had Bugs Bunny written all over it.  Be the tortoise and win your own race.