Facebook IPO: The art of pricing the right pop

Facebook's investment bankers are set to price the company's IPO late Thursday.

NEW YORK (CNNMoney) -- With seemingly unceasing demand for Facebook's initial public offering, the banks in charge of selling the stock to investors might seem to have the easiest job in the world.

But there's a delicate art to pricing the IPO. Lead underwriter Morgan Stanley (MS, Fortune 500) and the 32 other banks Facebook has tapped to sell the offering must decide on a price that causes the stock to pop in the first few days, while creating demand from the right type of investors: the "buy and hold" kind.

Facebook's underwriting team, which also includes JPMorgan Chase (JPM, Fortune 500) and Goldman Sachs (GS, Fortune 500), said the company is expected to sell shares somewhere in the range of $34 to $38 as of Tuesday. That's up from $28 to $35 previously disclosed. The company is expected to announce its official offering price after the market closes Thursday and begin trading on Nasdaq under the ticker FB (FB) on Friday.

Morgan Stanley and the other underwriters will be calling up clients hourly on Thursday to weigh demand at each price range before they set the final price.

To do it right, Morgan Stanley needs to leave its clients wanting more.

"Bankers want to have institutional buyers thirsting for more," said Alan Denenberg, a partner at the law firm Davis Polk who worked on the IPO of online reviews site Yelp (YELP). "You want unfulfilled appetite so investors go buy dessert in the aftermarket."

Should Morgan Stanley and the other banks underprice Facebook, the IPO could cost the social network tens of millions of dollars. Facebook would essentially be leaving money on the table. But if the banks overprice the offering, the underwriters risk scaring away long-term investors.

"There's a genuine inherent conflict in pricing the IPO," said Lise Buyer, founding principal of the Class V Group, who worked on Google's (GOOG, Fortune 500) offering. "The [investment banks] are trying to serve both buyers and sellers. The buyers are the big institutions that are clients of the bank each and every single day."

In many cases, big mutual funds like Fidelity and T. Rowe Price (TROW) that will own shares at the offering price typically have more pull with bankers. So the underwriters would rather err on the side of giving them juicy returns over the short and long-term.

On Wednesday, Facebook said it would offer another 421 million shares to investors, adding $3.19 billion in proceeds if Facebook prices at the top of the range.

But there's a question of just how much of a pop investors will see initially and over the long haul. Since 2011, Internet IPOs have soared dramatically on their first day of trading, only to cool off in the next few months.

Groupon's (GRPN) stock spiked 11% on its first day of trading, but its shares are down 53% since it went public in November 2011. Morgan Stanley also served as the online coupon company's lead banker.

On average, Internet IPOs traded up 34% on the first day, according to the research firm ABR Investment Strategy. Currently, those Internet IPOs are trading just 8% above the offer price.

While returns haven't been great for buy and hold investors, some investors (fairly or not) judge the success of an offering by how much it goes up on its debut day.

"If a stock doesn't pop after IPO, the offering can be viewed as a failure," said Nathan Drona, senior Internet analyst at ABR Investment Strategy.

But the bankers also have to think of themselves. Underwriters are charging smaller fees than usual to help sell Facebook to the public. But they are clearly hoping that working with the social network now could help them land potentially more lucrative merger advisory work down the road.

Facebook has already shown an appetite for deals by recently scooping up Instagram for $1 billion.