In the run-up to Facebook's $16 billion IPO, Morgan Stanley, the lead underwriter on the deal, unexpectedly delivered some negative news to major clients: The bank's consumer Internet analyst, Scott Devitt, was reducing his revenue forecasts for the company.
The sudden caution very close to Facebook's initial public offering - while an investor road show was under way - was a big shock to some, said two investors who were advised of the revised forecast.
They said it might have contributed to the weak performance of Facebook shares, which sank on Monday and Tuesday - their second and third days of trading - to end more than 18 percent below the IPO price. The $38-per-share IPO price valued Facebook at $104 billion.
Institutions and major clients generally enjoy quick access to investment bank research, while retail clients in many cases only get it later. It is unclear whether Morgan Stanley only told its top clients about the revised view or spread the word more broadly. The company declined to comment when asked who was told about the research.
The change in Morgan Stanley's estimates came on the heels of a May 9 Facebook filing of an amended prospectus with the U.S. Securities and Exchange Commission, in which the company expressed caution about revenue growth due to a rapid shift by users to mobile devices. Mobile advertising to date has been less lucrative than advertising on desktops.
"This was done during the road show - I've never seen that before in 10 years," said a source at a mutual fund firm who was among those called by Morgan Stanley.
JPMorgan Chase and Goldman Sachs, which were also major underwriters on the IPO but had lesser roles than Morgan Stanley, also revised their estimates in response to Facebook's SEC filing, according to sources familiar with the situation.
Morgan Stanley said in a statement that a "significant number" of analysts in the IPO syndicate reduced estimates after Facebook's May 9 disclosure. The investment bank said its procedures complied with all "applicable regulations."
Devitt did not return phone messages seeking comment. JPMorgan and Goldman declined to comment.
Typically, the underwriter of an IPO wants to paint as positive a picture as possible for prospective investors. Investment bank analysts, on the other hand, are required to operate independently of the bankers and salesmen who are marketing stocks. That was stipulated in a settlement by major banks with regulators following a scandal over tainted stock research during the dot-com boom.
The people familiar with the revised Morgan Stanley projections said Devitt lowered his revenue estimate for the second quarter and also cut his full-year 2012 revenue forecast.
The new revenue forecast was $4.85 billion for 2012, versus more than $5 billion earlier, one of the people said.
For the second quarter of 2012, the new revenue estimate was $1.111 billion, down from about $1.175 billion previously, the person added.
The second-quarter revenue forecast suggested that Facebook's year-over-year revenue growth might slow from the first quarter of 2012, one of the investors said.
"That deceleration freaked a lot of people out," the investor added.
Scott Sweet, senior managing partner at the research firm IPO Boutique, said he was also aware of the reduced estimates.
"They definitely lowered their numbers and there was some concern about that," he said. "My biggest hedge fund client told me they lowered their numbers right around mid-road show."
That client, he said, still bought the issue but "flipped his IPO allocation and went short on the first day."
Sweet said analysts at firms that are not underwriting IPOs often change forecasts at such times. However, he said it is unusual for analysts at lead underwriters to make such changes so close to an IPO.
"That would be very, very unusual for a book runner to do that," he said.
The lower revenue estimate came shortly before the IPO was priced at $38 a share, the high end of an already upwardly revised projected range of $34 to $38, and before Facebook increased the number of shares being sold by 25 percent.
"It's very rare to cut forecasts in the middle of the IPO process," said an official with a hedge fund firm who received a call from Morgan Stanley about the revision.