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Facebook's Flop: Why Stock's Early Slump May Not Matter

Tuesday, 22 May 2012 | 10:28 AM ET

While Facebook has already gone down in history as one of the great initial public offering flops, history also shows that the social media IPO dog could eventually hunt.

An image of Mark Zuckerberg, chief executive officer of Facebook Inc., left, with Robert Greifeld, chief executive officer of Nasdaq OMX Group Inc. remotely ringing the opening bell for trading is projected on a screen at the Nasdaq MarketSite in New York.
Peter Foley | Bloomberg | Getty Images
An image of Mark Zuckerberg, chief executive officer of Facebook Inc., left, with Robert Greifeld, chief executive officer of Nasdaq OMX Group Inc. remotely ringing the opening bell for trading is projected on a screen at the Nasdaq MarketSite in New York.

Facebook is a rare failure among IPOs and, especially, large IPOs. On average, they trade up by 20 percent on day 1, according to Jay Ritter of the University of Florida, a leading expert on IPO performance.

That compares with Facebook’s flat performance on Day 1 and near-11 percent decline on Day 2. Only one in four of all IPOs start flat to down, putting Facebook in a unique group of losers.

CNBC asked Ritter to run some numbers: How do IPOs perform six-months out based on how well they come out of the chute?

The initial conclusion is not promising for Facebook shareholders. IPOs that close down on Day 2 return 3.9 percent to shareholders after 6 months, underperforming the market for similar sized companies by 2.7 percent.

IPOs that pop out of the chute return 8.1 percent, beating other companies by 2.5 percent.

What Happens When IPOs Get a Bad Start?
An underperforming initial public offering doesn't necessarily mean disaster for the stock's long-term future. CNBC's Steve Liesman reports on some IPO busts that turned things around.

But CNBC asked Ritter to go further and look at the numbers based on company size, since his earlier work showed differences in overall IPO performance based on total revenue. Ritter came back with a bit of hope for retail investors who bought Facebook.

It appears that nearly all the underperformance of the IPO flops comes from small companies or those with less than $100 million in revenue. This group of smaller IPOs that closed down on Day 2 lags the broader market by 5.9 percent after six months. A small company that is born healthy stays healthy and beats the market by 1.9 percent on average.

But when it comes to larger companies, those with more than $100 million in sales, the data surprisingly shows it’s better to fail early on.

Large IPOs that trade down on Day 2 outperform the market by 8.1percent after six months. Those that do well on Day 2 outperform the market by only 2.5 percent.

The reasons for this aren’t exactly clear to Ritter. He cautions that the data set, even though it runs from 1990 to 2010, contains only a limited number of large company IPO flops. It makes him wary of saying that it’s good to flop.

But Ritter does feel comfortable saying that, at least on initial examination, there doesn’t seem to be much correlation between the early performance of a large IPO and the returns 6-months later.

”Maybe FB is saved,” Ritter wrote in an email. “For big company IPOs, what happens in the first two days doesn’t predict what happens over the next six months.”

"Maybe FB is saved... For big company IPOs, what happens in the first two days doesn’t predict what happens over the next six months." -IPO Performance Expert, University of Florida, Jay Ritter

What the data seem to show is that small companies don’t get second chances but larger companies do.

Influences on the share price of IPOs after the offering including the eventual withdrawal of support in the secondary market from underwriters, eventual filings of earnings reports and the end of lock-up periods, allowing insiders to sell their stock.

So as each day goes by, the share price of Facebook will increasingly rise and fall on its actual performance and the broader market as fund manager lump it in with stocks of similar size and in similar businesses.

One notable IPO flop, Refco IPO’d at $22 and shot up to $27.48 on Day 1. Six months later, the stock was trading on the pink sheet at 80 cents after revelations of accounting fraud.

From the other side, the mining concern Molycorp came out of the chute at $14 and sank 13 percent on Day 1 to $12.23. But six months later, it had bounced back to $46.81.

As for Ritter, he received a 400 share allotment of Facebook and plans on holding on to the shares.

-By CNBC's Steve Liesman
@steveliesman

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