Investors Pummel Facebook

By JACOB BUNGE, AARON LUCCHETTI and GINA CHON
Stock Falls 11% in First Full Day of Trading; Complaints of Too Many Shares.

Criticism of the Facebook Inc. stock deal grew as the shares dropped below their offering price in their first full day of trading Monday, wiping $11.5 billion off the social network's market value.

The company, its investment bankers and the Nasdaq Stock Market came under fire for failing to ensure a smooth debut for one of the most anticipated deals in recent memory. Facebook shares, which began trading Friday at $38 and managed to add just 23 cents by the end of that day, fell 11% Monday to $34.03.

The selloff came partly because some investors who were allotted more Facebook shares than they expected moved to pare their holdings, said people familiar with the matter. Retail, or individual, investors usually are allocated up to 20% of the total shares allotted in an IPO, but in Facebook's case, retail allocation was around 25%, the people said.

Days before the initial public offering, Facebook, whose executives played an active role in the IPO process, according to people familiar with the matter, increased both the price and the number of shares being offered. As a result, many retail investors weren't hungry for more shares once trading began, according to the people.

A representative for Facebook declined to comment. The company raised $16 billion in the offering.

George Brady, a 66-year-old recruiter in North Carolina, bought 1,000 shares of Facebook a few minutes after it opened for trading Friday. He said by Monday morning, he sold his holding, taking a $2,770 loss.

Mr. Brady said he tried not to purchase the shares in the first place, but was unable to withdraw his order on his Charles Schwab account, calling the situation "ridiculous." Technical problems on the Nasdaq Stock Market prevented some investors from confirming their trades or trade cancellations.

"I was stuck for six hours trying to figure out whether I owned this dog or not," said Mr. Brady. He said he has been in touch with Schwab. Schwab didn't return a call requesting comment.

Facebook's offering, one of the biggest U.S. IPOs, was supposed to burnish the reputations of Morgan Stanley, the deal's lead banker, as an underwriter, and Nasdaq OMX Group Inc. as the listing exchange of choice for hot technology companies.

"This has been a train wreck," said one hedge fund manager, whose fund also decided to sell some of its shares Monday. He said his fund was allotted 500,000 more Facebook shares than he expected.

The hedge-fund manager acknowledged that his fund and others asked for more than they wanted, thinking that they would only get half or less than they ordered, as usually happens in an IPO that is expected to have high demand. With some investors, including retail shareholders, getting a larger than expected allotment, demand was already dampening.

As a result, he had a bad feeling about Facebook going into the beginning of trading. On Monday, he said he was "spooked." Even though it wasn't a moneymaker, his fund decided to sell some shares because of worries about the flood of shares that could hit the market later after employee lockup periods end.

Some investors faulted Morgan Stanley and Facebook for overloading the market with too many shares. Just before the offering, Facebook expanded the number of shares by 25%, to 421.2 million.

"The underwriters completely screwed this up," said Michael Pachter, an analyst at Wedbush Securities. The offering "should have been half as big as it was, and it would have closed at $45."

A person familiar with the matter said Morgan Stanley did what it was "paid to do," adding the bank "stood by the client and supported the issue."

At $34 a share, Facebook has a price-to-earnings ratio, a measure of how expensive or cheap a stock is, of about 85 times projected earnings for the next 12 months, according to CapitalIQ. By comparison, Google Inc. trades at 13 times earnings.

"Facebook's IPO priced at a level well-above where we foresaw compelling 12-month returns," BTIG analyst Richard Greenfield said in a research note Monday. With revenue and earnings growth decelerating in 2012, "we find Facebook's current valuation unappealing."

The stock closed a hair above the $38 IPO price during Friday's trading debut, after Morgan Stanley stepped in to prop it up, according to people familiar with the matter. As the deal's so-called stabilizing agent, Morgan Stanley could support the stock through a pool of Facebook shares known as an overallotment. But on Monday, the shares lost their footing, at one point touching $33.

"What you saw today was a marketplace that felt pretty certain the bankers were long more stock than they wanted," Michael Shea, managing partner at Direct Access Partners, a financial-services firm, said Monday.

"You could see the halfhearted attempt to hold the stock at 38 this morning during premarket trading," Mr. Shea said. "When the decision was made and the buyer stepped away, it took less than five minutes for that stock to trade down a dollar."

Mr. Shea, whose firm has only institutional clients, declined to comment about whether his clients bought or sold Facebook stock on Monday.

Steve Bishop, the portfolio manager for the RS Technology Fund, with $235.3 million in assets, said his fund bought shares of Facebook through the allocation process last week, but then quickly sold them "somewhere in the 40s" shortly after the company when public on Friday.

Mr. Bishop said he felt the IPO "was getting a little frothy," which is why he decided to sell directly after the IPO. He also described the IPO as "overhyped."

While some investors received more shares than they expected, one person familiar with the deal said many institutions were allocated "dramatically less" than the amounts they had requested. The person noted that the shares opened about $4 above the offering price on Friday and said Nasdaq's technology snafus left even Morgan Stanley's bankers and traders in the dark on the status of their positions.

Problems with Nasdaq's IPO mechanism Friday had led to an approximate 20-minute period in which the exchange stopped confirming new orders for the shares, as well as cancellations or changes to standing orders.

Traders said there weren't any problems trading the shares by later Monday.

Nasdaq officials told clients they would have to seek "accommodation" through the exchange's rules for handling disputed transactions. In such situations, brokers can petition the exchange to get compensation for losses proven to be the result of Nasdaq systems failures.

Nasdaq hopes to earmark at least $13 million to resolve bad trades, a company spokesman said. But this figure may undershoot the financial damage sustained by brokers who made up losses for retail and institutional investors that had trades affected by the glitches.

The Financial Industry Regulatory Authority, or Finra, a Wall Street regulator, will oversee arbitrating and distributing the money to firms, Nasdaq told traders Monday. Finra will review trading data and issue a report to the exchange detailing the "total value of all valid claims," according to the notice. A spokeswoman for Finra declined to comment.

Exchange staff told brokers Monday that the process of parsing Friday's trades and determining which losses would be compensated could take one to three weeks, according to people involved in the discussions. Nasdaq is planning to hold a conference call Tuesday to further detail the process, brokers said.