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Facebook Flop May Create a Silver Lining for IPO Investors

Facebook’s seemingly disastrous debut will likely mean fewer initial public offerings at even lower prices, ultimately a positive for investors.

Facebook IPO hat
Photo by Jodi Gralnick for CNBC.com
Facebook IPO hat

“Ironically, this is a huge plus for the IPO market,” said David Menlow, president of IPOFinancial.com. “Issuers and underwriters alike will overreact with below average pricings moving forward; and that means value for investors.”

Kathy Smith, a principal at Renaissance Capital, agrees. “Issuers of future IPOs will have to offer lower valuations to avoid such failures, enabling IPO buyers to make money,” she said.

Without the full support of underwriters, the social networking giant broke its IPO offer priceof $38 a share at the market open Monday. Facebook’s shares closed just pennies above the offer price on the first trading day and finished down 11 percent on day two.

The Facebook debacle comes at a very tumultuous time for the broader equity market, which logged the worst decline of the year last week. The cumulative effect will likely be a significant slowdown in the already weak IPO activity in the coming weeks, say analysts.

Morningstar’s analyst James Krapfel thinks many companies will hold off going public, as their valuations are unlikely to reach desired levels. Lower quality offerings will have an even more difficult time to price successfully than before.

“The weak action clearly shows that some of the speculative froth in technology IPOs has abated — welcome news in our view,” added Krapfel, who was very surprised to see Facebook flop given high retail demand for its shares.

Smith thinks the Facebook IPO was very poorly executed.

“The underwriters and the company misjudged the appropriate valuation needed to attract post-IPO orders,” she told CNBC.

“This is a very tricky IPO environment. IPO investors are not buying every deal at any price,” Smith said. “It is a buyers’ market and the issuers, venture capitalists and underwriters have not fully adapted to that.”

Smith notes that Facebook’s marketing period coincided with a dramatic decline in returns on newly public companies. Half of the 2012 IPOs are now underwater, according to Renaissance Capital.

Among other factors contributing to the Facebook weakness, analysts named a large and expanded supply of offered shares, pre-IPO news about increased insider selling and GM pulling Facebook ads, as well as order execution glitches on Nasdaq. The exchange now says it will alter its IPO trading procedures.

Menlow, who expected Facebook to do extremely well, said the company’s disappointing debut Friday could have easily become a disaster. “If the stock market closed a half hour or even 15 minutes later, the stock would not only have broken the IPO price but would have seen massive liquidations of an epic scale,” Menlow said.

Menlow is not giving up on Facebook, but said the company now is under even more pressure to deliver than before.

“All those who were pitching the negatives about the offering, vis-a-vis the fundamentals, corporate governance, stagnating market growth from new users, inabilities to monetize mobile, will all be standing on their soapboxes,” Menlow said. “The absence of any new news items from the company will provide a fertile environment for the media to be overpowered by those who subscribe to those issues.”

President of IPO Desktop Francis Gaskins, who was skeptical of the Facebook IPO from the get-go, expects the company’s shares to trade in the $18 to $20 range by end of this year.

“There is an enormous overhang of shareholders wanting to get out, who have low cost basis or purchased in the past 18 months hoping for a more positive IPO,” Gaskins noted.

“Zuckerberg's continued lack of credibility with Wall Street means investors won't necessarily buy into company’s estimates,” Gaskins added.

“Going on a honeymoon right after a disastrous IPO kind of confirms that he's not fully committed to further enhancing shareholder value, seems to me,” Gaskins said.

Questions? Comments? Email us at marketinsider@cnbc.com and follow me on twitter @kfrayter

Disclaimer

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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