With Facebook Finger-Pointing, Blame the Price

With the Facebook IPO quickly spiraling into debacle territory, the news media and the investment banking community are piling on, pointing fingers in all sorts of directions at all sorts of folks.

This morning, Facebook shares are trading a new post-IPO low of around $31.90, down 6% on the day. (The shares were sold in the IPO at $38.) At the same time, new allegations are surfacing about the flawed Nasdaq handling of trade confirmations during the IPO and changes to analyst estimates during Facebook's roadshow.

You can track the IPO in real-time below.

Meanwhile, facebook Founder and CEO Zuck's net worth has plummeted nearly $3 billion since the IPO. Bad week, eh?

All of these are problems, but ultimately you can blame the price. Stocks that are priced highly on a price/earnings (P/E) or price/sales (P/S) basis have much less of a margin for error than stocks with reasonable valuations. Facebook's high valuation -- and the bankers' last-minute changes in the terms and the number of shares -- flooded the market with stock just when the company had a bloated valuation and more questions were being raised about its business.

The market is an arbiter of price based on supply and demand. Technical problems can cause price distortions and supply/demand imbalance in the short term, but a company's share price is determined in the long run by the amount of value it creates.

When you float a company at a P/E of 90 and a P/E of 25, it sets up the potential for big price stumbles. Back when the tech bubble was ending in 2000, I made a rule never to pay more than 10 times sales on a company, no matter how well it was doing or how fast it was growing. I have seen far too many 10X or 15X sales companies blow up in the past. It's a bad risk/reward bet. Facebook traded out of the gate at 25 times sales.

Let's look at some of the other developments surrounding this ugly IPO:

• This morning, Reuters reported that analysts at Facebook's lead underwriter, Morgan Stanley, cut revenue forecasts for the company and selectively disseminated this information. Reuters says this was done during the roadshow leading up to the float. If true, this is a big problem for Morgan Stanley, and it will likely lead to an investigation to see if the firm broke Regulation FD rules.
• Nasdaq is fessing up to all sorts of technical problems with the IPO, including bad calculations of the opening price, incomplete trade confirmations, and quoting problems. "It was like the gang that couldn't shoot straight," a Fiduciary Trust employee told Bloomberg about the Nasdaq and the underwriters.
• Having major clients openly discuss problems with the core business model just a week before the IPO does not help the situation.

What should traders or investors do? Ultimately, an investment decision has to be based on a company's price and valuation. Other issues surrounding the Facebook IPO are catalysts for the price movement, but the company was set up for failure by having its stock priced too high going into the IPO. This was a combination of bankers trying to push things too high and insiders getting greedy.

The market is a price-discovery mechanism, and that mechanism is clearly broken. At this point, I don't think the market is going to have a fair or accurate method for discovering the price of this company until its stock has been trading for several months and the company has at least one earnings release under its belt. Right now, things are still too messy to figure out the trajectory of the company -- or the price.

I say stay away, unless the price drops to the mid-20s, in which case it gets more interesting.

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