Facebook's bungled IPO ticks off investors

Robyn Beck / AFP - Getty Images

The entrance to the Facebook main campus in Menlo Park, Calif.

By Roland Jones

Ivette Vazquez, a restaurant manager in Jersey City, N.J., thought she was jumping into the next big technology boom when she bought 100 shares of Facebook at $40 a share as the social media company launched its initial public offering of stock last Friday.

?I was caught up in the excitement of an enormous social media company going public and thought that over the long run, the investment would be profitable,? she said. ?It?s a service I use several times a day, and that?s how I like to invest -- in things I use.?

What happened next didn?t follow the traditional script for technology IPOs.

After a brief and slight gain in value, Facebook?s share price dropped below the offering price of $38, where it has remained ever since. Watching her investment turn sour has left Vazquez a little jaded, but not permanently discouraged by the idea of investing in the market, she said.

?It?s disappointing, but I think it?s an isolated thing and I don?t think it will change the way I invest in the future,? said Vazquez. ?I would have expected a little bit more from the way the IPO was handled though. Now I guess I will hold on to the stock and hope it turns around in the future.?

With individual investors losing hundreds of millions of dollars in Facebook?s first stock offering, experts say the bungled IPO -- and allegations of selective disclosure of information about the company?s business prospects to certain preferred investors -- could increase the disgust individual investors feel for the stock market and investing in general.

?There has been, without question, a chilling effect that has swept across the investing landscape after the Facebook IPO,? said David Menlow, president of the research firm IPOfinancial.com.

?Individual investors had been cowering in the corner since the mortgage meltdown of 2008, wondering if it?s safe to go back in the water, and now they?ve been burned again,? Menlow said.

Facebook reportedly set aside some 25 percent of its shares for regular retail investors -- or about 105.3 million of the 421.2 million shares the company said in a regulatory filing that it expected to sell in its public offering.

Related: Facebook investors could recoup losses in court

If that group of retail investors had bought their stock at the IPO price of $38, by Thursday?s close the value of their collective investment would have declined by $526.5 million, or 13 percent, based on the closing price of $33 and assuming those investors have not sold the stock.

Jay Ritter, a professor of finance at the University of Florida and an expert on IPOs, said that research shows individual investors tend to overweight recent experience.?If an investor has lost money in Facebook, he or she will be less likely to make any IPO investments over the next few months.

Indeed, although there are no high-profile IPOs planned for the foreseeable future, at least one company -- Tria Beauty, which sells cosmetics and other beauty products -- has postponed its IPO planned for this week, citing market conditions.

Ritter said he didn?t buy any IPOs in 2010 and 2011, but he purchased 400 Facebook shares at the offer price.

?I don?t buy a lot of IPOs, but I did buy Facebook,? he said, adding that the experience of many investors was likely similar to his -- they?bought into Facebook because of the media attention given to its stock offering, and are now feeling sorry they did.

?The main reason I bought Facebook stock was I expected a big jump on the first day,? he said. ?I thought it would go to $49, but I was wrong.?

Ritter said the negative experience of the little guy isn?t likely to have a major impact on the financial markets, however.

The 25 percent number for individual investors in Facebook?s IPO is not typical, he said. The portion of shares going to individual investors from most IPOs is usually about 15 or 20 percent. The dominant buying group for these investments is hedge funds and other wealthy institutional investors.

?I don?t think there?ll be any lasting changes from what happened,? Ritter said. ?Institutional investors are the main buyers of IPOs. It has been that way for years and I expect it to be that way for years to come.?

Ritter also noted that the money investors lost in the Facebook IPO is tiny compared to the overall market.

So far in May, the overall aggregate losses in the stock market total around $1 trillion, as the market has declined in value from around $16 trillion to $15 trillion.

In round numbers, all investors in Facebook have lost around $3 billion from Friday to Thursday?s close -- that?s 0.3 percent of the overall losses in the aggregate market in the past month or so, he said.

But while the impact from the bungled Facebook IPO may not have a major impact on the financial markets,?it could be widespread, he added. One of the noteworthy aspects of the offering is not what happened to the stock price, but how large the deal was.

Some $16 billion of shares were sold, and if you take 25 percent of that amount you get around $4 billion -- approximately equivalent to the total dollar amount individual investors invested in IPOs in each of the past two years.

Facebook?s IPO was also vastly oversubscribed, and this likely made it difficult for the banks running the offering -- Morgan Stanley and others -- to price it. Critics say the underwriting banks set the price of the offering too high and sold too many shares to the public.

Related: Facebook dream IPO now looks like a nightmare

The bungled IPO was further complicated by technical problems at the Nasdaq stock exchange when the shares opened for trading last Friday, with millions of Facebook trades improperly executed. These problems feed into a sense?among individual investors that the odds are stacked against them in IPOs.

IPOfinancial.com?s Menlow notes that underwriting banks typically allocate IPO shares to their best clients, which include hedge funds, wealthy individuals and large institutional investors. These investors will get the right to buy a certain number of shares at the offering price. Everyone else has to take their chances in the open market.

?The game is rigged here,? said Menlow. ?The problem is brokerages are mainly interested in deals with high net worth individuals; when deals are done with individual investors they need more coaxing.?

A more effective method of selling Facebook?s stock might have been to copy the method used by Google in 2004.

Google used an Internet-based auction model for its IPO, instead of a more traditional method using investment banks and other financial companies to find buyers. The ?Dutch auction? model allows anyone, not just Wall Street insiders, to buy stock in an IPO.

Bill Hambrecht, W.R. Hambrecht & Co. co-founder and CEO, who worked with Google to set up their Internet-based auction for stock, says the Dutch auction method is more effective because it limits the ability of the investment bank running a deal to influence the opening price.

?The way the IPO system works is it?s an insider?s game, the underwriter has the right to allocate to his clients,? he told CNBC. ?They call it an initial public offering, but it?s not public at all.?

Hambrecht notes that much of the demand for a traditional IPO is not from people who want to own the stock for the long term, but from investors who want to get the stock at the opening price, and then immediately resell it the next day.

?When you really think about it, that?s the greater fool theory -- you?re buying a stock not based on what you think it?s worth, but what you think you can sell it to someone else for,? he added.

Click here to check Facebook's share price.

Who is to blame for Facebook's IPO fumble?

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