Facebook Analysis: Did Underwriters Dupe Retail Investors?

Facebook (NASDAQ:FB) shares began trading in the public markets on Friday. At 11:30am ET, Facebook shares priced at $38.00 per share, began trading on the NASDAQ Global Select Market (NASDAQ:NDAQ) under the ticker “FB”. According to Reuters, the shares opened at $42.05, with 82 million shares traded in the first 30 seconds, and 100 million shares traded in under five minutes. On Friday, shares closed at $38.23, a 0.6% increase above the offering price, and above NASDAQ’s Friday decline of 1.2%. However, after Monday trading, shares closed down significantly by 10.99% at $34.03 per share, with a market cap of $93.24 billion.

Underwriter support likely kept Facebook shares trading at or above the offering price. We believe a substantial increase in the offering size caused supply to exceed demand. On Wednesday, the underwriters increased the offering to 421 million shares (180 million from Facebook (FB) and 241 million from selling stockholders, with 63 million more in over-allotment option) from 337 million shares (180 million and 157 million, with 51 million more in the over-allotment option).Shares outstanding total 2,138 million (633 million Class A, 1,505 million Class B).

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CEO Mark Zuckerberg exercised options for 60,000,000 Class B shares, offering 30,200,000 Class A common shares in the IPO. Mr. Zuckerberg owned 504 million shares after the IPO, with voting rights on 936 million shares. Due to the super-voting power of Class B shares, he now controls 55.9% of total voting power. Shares offered by executives and directors totaled 194 million. Executives and directors held 1.4 billion shares before the IPO, offering 14% of their holdings.

Facebook (NASDAQ:FB) changed the terms of its IPO in recent filings. The first revised Form S-1, released the week before the IPO, increased the offering price range to $34 – 38 from $28 – 35, while the second revised Form S-1 increased the number of shares to be offered to 484 million from 388 million assuming that the overallotment option was exercised. The number of shares to be offered by executives and directors increased to 189 million from 117 million. In addition, Mr. Zuckerberg’s voting power was lowered to 55.9% from 57.3%.

We believe the underwriters overestimated demand. The late addition of 84 million shares to the offering overwhelmed demand, limiting the first day price.

Maintaining our OUTPERFORM rating and 12-month price target of $44, which implies a 22x multiple on our hypothetical 2015 EPS figure of $2.00. We think that our price target is warranted due to Facebook’s huge upside potential for revenue and earnings growth.

Michael Pachter is an analyst at Wedbush Morgan.

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