Lead underwriter Morgan Stanley began doling out the $100 million or so in profit earned by banks as a result of Facebook’s initial public offering to the rest of the underwriters, according to reports.
The Wall Street Journal reported that the amount issued to each underwriter was calculated based on their participation in the IPO, adding that the profits were earned through a process known as stabilization, in which underwriters purchase shares at the IPO price in an effort to keep the stock from plummeting below that figure. Lynn Cowan of the Journal explained:
Stabilization works this way, people familiar with the process say: If investors are selling the stock after the IPO launches, pushing the price lower, bankers can step in and buy shares at the IPO price in an attempt to keep it from falling below its issue price. This also serves to cover their short positions. If a short position remains on their books and the stock keeps falling — which was the case with Facebook on subsequent trading days — the underwriters can continue to cover their short positions by buying back shares at prices below the IPO price, netting a profit.
There is no risk to the banks in this effort. If the stock only trades up, the short position is covered when banks exercise what is known as an overallotment option, buying more shares from the newly public company at the IPO price. The banks don’t lose money, and the new public company makes more money when the overallotment is exercised.
Readers: Does it surprise you that the underwriters of Facebook’s IPO were able to turn a profit of $100 million despite the poor performance of the stock?
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