Regulators raise questions about Facebook IPO after its disappointing performance

Facebook’s lackluster performance on Wall Street has investors wondering: What’s not to like?

After the social network’s stock fizzled on Friday in its long-awaited debut, its stock fell 11 percent on Monday and closed down 8.9 percent Tuesday, even as the rest of the stock market rallied. The stock was up 3.2 percent on Wednesday. 

Some have said Mark Zuckerberg pushed to overprice the stock because he wanted the symbolism of having his company valued at more than $100 billion, while others blame Friday’s unexpected glitches on the NASDAQ stock exchange.

Now serious allegations are surfacing about whether the IPO was mishandled by Morgan Stanley and other banks that helped orchestrate the public offering. 

On Wednesday, Facebook’s shareholders sued the social media giant and investment banks including Morgan Stanley, J.P. Morgan, and Goldman Sachs, alleging inadequate disclosure of key information. Specifically, the firms are accused of warning top clients that Facebook might not be such a good deal based on insider information, even despite Facebook’s May 9 revision of its IPO filing, which admitted that its ad revenue was not meeting projections.

Bloomberg news markets reporter Lee Spears said the general concern is Facebook’s public disclosure was very vague while the investment banks’ conversations with their top clients were very specific and clearly indicated that certain aspects of the business were trending downward.

“Facebook said in its filings something simply along the lines: Revenue is not growing as fast as the number of users. Morgan Stanley and the other investment banks were calling their clients and saying very precisely: This is how we think this will affect 2012 revenue, 2012 earnings, 2013 revenues and earnings,” Spears said. “It’s very unclear whether anything illegal was done, but on the face of what we know right now, it doesn’t seem like anything illegal was done.”

It is also unclear whether the investors who Morgan Stanley and the other underwriters were communicating with were the same people putting in orders for the stock at the top of the price range, propping it up.

“If there were any fraud-like activities, say for example, an underwriter knew something about a company that was blatantly fraudulent and did not tell his clients, that would be illegal. All we have here is that Facebook discovered that its prospects were trending downward a little bit. Facebook communicated this to its underwriters. Completely legal. The underwriters then communicated this to their clients. Also completely legal,” Spears said.

Bloomberg Businessweek writer Roben Farzad said Facebook’s problem speaks to an age-old problem on Wall Street of prioritizing one client’s interests versus another.

“In this case, you had one client of Morgan Stanley’s, Facebook, saying we want to get as high a price as possible; and another client, the institutional clients who are going to be the big recipients of this IPO, saying we expect you to give us more information at the outset. So then who’s stuck holding the bag is the little guy, the retail investor, A.KA., on Wall Street, ‘dumb money,'” Farzad said.

In some instances, some students reported buying shares at $38 apiece and then selling them at an 11 percent loss.

At $38 per share, Facebook is trading at 74 times its earnings. Apple trades at around 13 times its earnings and Google, around 18 times.

Farzad said the problem with a hyper-growth company like Facebook is that the stock’s high trading rate does not mean much because it is growing so rapidly.

“Similarly, I think the supporters of Facebook are saying that this is such a paradigm-shifting company that’s going to own whole swaths of the Internet and chunks of online advertising, that it’s premature at this point to assign a price earnings multiple to,” Farzad said.

According to Farzad, while the social media giant has proven that it can be effective in desktop advertising, the difficulty lies in the fact that the world is moving to mobile computing.

As more and more people are using their Facebook apps on their iPhones, iPads and Androids, Facebook has yet to figure out mobile advertising.

“It’s a whole different beast than the ads that pop out on the margins when you have a web browser opened up on your desktop or laptop computer,” Farzad explained.

Facebook’s stock climbed 3.2 percent Wednesday to close at $32, almost 16 percent below its initial public offering price. Facebook broke the record for the volume of shares traded in one day andis one of the largest IPOs in U.S. history, but the lawsuits, technical glitches and declining stock prices have analysts suggesting the company re-evaluate its worth.

“I think the one thing that they were really banking on was that there was going to be huge retail demand out there, that lots of mom-and-pop investors were going to be so eager to get their hands on Facebook stock, they would pay any price to get it. And that did not happen,” Spears said.