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Facebook's IPO And The Average Investor

Feb 3, 2012
Originally published on February 3, 2012 5:54 pm
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MELISSA BLOCK, HOST:

You might think from the breathless hype that the initial public offering announced by Facebook will change all our lives. Here's how CNBC delivered the news this week.

(SOUNDBITE OF CNBC BROADCASTS)

UNIDENTIFIED WOMAN: Facebook may file for its IPO as early as today to raise $5 billion. Morgan Stanley...

UNIDENTIFIED MAN #1: Companies already getting a boost from Facebook. Pete Najarian...

UNIDENTIFIED MAN #2: All right. Come on. Facebook, Facebook. What could be more exciting...

BLOCK: Indeed, what could be more exciting? But if you're thinking, hey, I'd like to get in on that IPO, keep thinking. Chances are the large majority of us are way at the back of the line.

Here to explain who can get Facebook shares and how an IPO works is Dennis Berman. He's marketplace Editor at The Wall Street Journal. Dennis, welcome to the program.

DENNIS BERMAN: Hi.

BLOCK: Let's start just by defining an IPO. When a private company issues stock to the public in this initial public offering, why do they do that?

BERMAN: Well, there are usually a number of reasons. The first one, which goes largely unstated, is that the founders and investors of the company want to get rich. The second reason, which is the reason that's touted to investors, is the company needs money to fund its operations. We're going to build a new product, build a new factory or hire a bunch of people so we can make more money for the shareholders.

BLOCK: So when the IPO for Facebook is launched, when it's listed on a stock exchange, how is the offering price per share of stock set? What does that depend on and who sets that?

BERMAN: These are the dark arts and this is where the underwriter comes in and maybe we'll talk about that in a moment, but Wall Street banks working with investors who are, quote, "on the buy side," they try to determine the best price possible for the issuer. That's the company: Facebook.

Now, there are a lot of scientific things that go into this, but the art of it is trying to price it at a level where the stock is not going to go down on the first day and probably might have a nice bump in the first day of trading.

What you don't want to happen if you're a company or an underwriter, is to have a huge first day bump, which means that you've left money on the table.

BLOCK: You've left money on the table, meaning you could have priced those shares higher?

BERMAN: Right. So let's say I'm Facebook and I want to sell at $20 a share, and the real end demand is at $30 a share, I've lost $10 a share of value that I could bring into the company. So there's science, there's art, there's ego, there's ambition. All these things factor in to make an IPO work and it's fascinating to watch when it does happen.

BLOCK: OK. So the day of the IPO arrives. Who is it who gets to buy shares in Facebook on that opening trade?

BERMAN: Well, not you, not me and probably not most listeners. In a very hot IPO, what happens is the underwriters - and these are largely big banks. You know their names. Goldman Sachs, Merrill Lynch. They allocate shares that they've purchased from the company to their customers.

Now, it's not any old Joe who has a small brokerage account at Merrill Lynch. Most of the time, these shares go to the best clients and those best clients often are big institutions, hedge funds, other big money managers and the most high net worth individuals.

BLOCK: And if I, as a - you know, I'm a Facebook user. If I go to Morgan Stanley and I say, look, I want one share of Facebook. Deal me in. Why can't they do that?

BERMAN: Well, because life isn't fair and they allocate the best opportunities for the best customers. Now, they would say to you, hey, Melissa, if you want to buy the Facebook share, great. Open an account, and once it starts trading, you can go into the market and buy that piece of stock.

BLOCK: And I just have to wait?

BERMAN: And you'd just have to wait. Now, what's wrong with that? Well, you missed, probably, the opening day pop and that's why these things are so valuable because there really is, a lot of times, money embedded just by being before the general market.

BLOCK: Dennis Berman is marketplace editor at The Wall Street Journal. Dennis, thanks so much.

BERMAN: You're welcome. Transcript provided by NPR, Copyright NPR.