It's a customary gesture from underwriters to support the company they helped bring to market, explains Jay Ritter, a finance professor at the University of Florida. It's a way to save face and show that the company and the bankers gauged an appropriate level of demand from investors and valued the company correctly.
Pulling off a successful IPO means properly gauging supply and demand. The underwriters work with the company to decide how much stock to sell and at what price. Facebook sold 421 million shares. That was a lot of stock to sell. It is one of the largest IPOs on record.
Investors and the technology industry are closely tracking the Menlo Park, Calif.-based company's shares. In the same way that Netscape ushered in a new era for Internet darlings in 1995, Facebook may have done the opposite for similar companies waiting to go public today. There are 168 companies in the pipeline trying to raise $41 billion through IPOs in the U.S.
"Facebook has raised cost of capital for all the companies that come with an IPO in its wake," said Smith.
Facebook's falling share price may be a sign that investors are taking a rational look at the company's financial performance in comparison to its peers.
Though there are many ways to judge if a stock's price is too high or too low, one popular method is to compare it to earnings. The so-called price-earnings ratio, divides a company's stock price by the company's annual earnings per share. A higher ratio suggests a stock is expensive because, in a sense, it takes more years of earnings for investors to get back they paid for it. A lower ratio suggests it is cheap.
By this logic, Facebook looks expensive compared with some companies. It is trading at 74 times its earnings in the past year, according to FactSet, a research firm. That compares with Apple at 13.7 times and Google at 18.6 times. The Nasdaq index of technology stocks trades at 20.8 times.
"There must have been some sober second thoughts about this," said Brian Wieser, an analyst at Pivotal Research Group who was first to come out with a "Sell" rating on Facebook's stock on Friday.
It's not that he believes the world's largest online social network is a bad investment. But at $38 per share, it's just too expensive considering the risks associated with Facebook's brief history and unproven advertising model, he says. His fair price, or "target price," is $30.
Wedbush analyst Michael Pachter, who came out with an "Outperform" rating on Facebook before its IPO, said he believes the investment banks that arranged the offering overestimated demand for the company's stock.
Facebook originally set a price range of $28 to $35 for its IPO, which would have valued the company at $95 billion at the high end. Last Tuesday, though, it increased the price range to $34 to $38 per share, valuing the company at as much as $104 billion.
Then, responding to extraordinary demand from prospective investors, the company announced on Wednesday that it would add 84 million shares to the offering. The shares came entirely from the company's early investors — such as Goldman Sachs and venture capitalist Peter Thiel. The fact that these investors were offloading more stock instead of hanging on to it may have served as a warning sign to new investors.
"The late addition of 84 million shares to the offering overwhelmed demand, limiting the first day price," Pachter said in a note to investors.
Aside from rational risk calculations, some investors "un-friended" Facebook for emotional reasons on Monday. Alper Aydinoglu, a student at DePaul University in Chicago sold all 50 shares that he got via E-Trade at $38 last week. He took an 11 percent loss.
"I'm not willing to stick through the volatility," Aydinoglu said.
AP Business Writers Bernard Condon and Michelle Chapman contributed to this story.
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