Saturday, February 4, 2012

Facebook's IPO Is Not About Owning Facebook

Facebook is going public, but that does not mean purchasers of Facebook stock will own the company in any real way. Instead, investors must know that they are buying an ownership interest not in Facebook, Inc. but a share in the vision, judgment and actions of CEO Mark Zuckerberg.

After the IPO, Zuckerberg will own 56.9% of the voting shares. This means he will still get to call the shots in profound ways; for example, the S-1 filing reveals Facebook will be a "controlled company." That means the board of directors will not have an independent nominating function and may elect "not to have a majority of our board of directors be independent or not to have a compensation committee."

In addition, Facebook will have two classes of stock--Class B shares have ten times the voting power as Class A shares. Zuckerberg has a controlling portion of Class B shares, and his control is likely to rise because Class B shares become Class A shares as Class B owners sell. Moreover, the IPO contains an unusual clause that means Zuckerberg will exert power over Facebook even after death:

"…in the event that Mr. Zuckerberg controls our company at the time of his death, control may be transferred to a person or entity that he designates as his successor... As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as a result of voting agreements, in his own interests, which may not always be in the interests of our stockholders." 
Facebook's S-1 makes it clear what this all means to investors: "Our status as a controlled company could cause our Class A common stock to look less attractive to certain investors or otherwise harm our trading price."

And, "Mr. Zuckerberg will be able to effectively control all matters submitted to our stockholders for a vote, as well as the overall management and direction of our company."

And one of the 13 risk factors cited in the filing is: "Our CEO has control over key decision making as a result of his control of a majority of our voting stock."

Should investors be concerned with this? That depends in large part on what you think of Mark Zuckerberg. Many criticize him for Facebook's approach to privacy (and the S-1 notes that privacy laws "are subject to change and uncertain interpretation, and could harm our business.") But there is another side to Facebook's CEO--the one that demonstrates a commitment to grow the company's revenue model steadily and in a way that does not annoy users. Some investors may shy away from Facebook because of this measured approach to advertising growth, but it leaves me feeling more optimistic about Facebook's future.

Every page on Facebook has some advertising, but it tends to be highly targeted and unobtrusive. There are no banner ads, no interstitials, no dancing animated ads, no Flash ads with hidden "close" buttons and no takeovers. Facebook tries to make advertising as relevant as possible, not merely by permitting typical demographic targeting, but also allowing advertisers to target your and your friends' likes. (Admittedly, the way some brands are accumulating "Likes" undermines the authenticity of this sort of social advertising, but I see Facebook working to make advertising more relevant and not less.)

Facebook's cautious approach is even more evident on mobile, which the S-1 acknowledges is a crucial platform for the firm. At this point, there are no mobile Facebook ads despite the fact more than half of Facebook's 845 million MAUs (monthly active users) utilized a Facebook mobile product in December.  Facebook is so careful about launching mobile advertising that the S-1 notes, "Growth in use of Facebook through our mobile products, where we do not currently display ads, as a substitute for use on personal computers may negatively affect our revenue and financial results."

I am not a financial adviser and am not dispensing investment advice, but I have already shared my opinion that a social media bubble has formed and is already bursting. My feelings are no different about the Facebook IPO from other social IPOs--the likely price presupposes a pace of growth that Facebook will be challenged (and probably unwilling) to accomplish. I would not be surprised to see the value of Facebook stock drop in the short-run as has happened with virtually every other social IPO thus far.

While I would not buy Facebook in the immediate future, there is every reason to think the stock will make a smart long-term play at some price in the future. Look at Ebay, which two years after its IPO hit a peak of $30.47 and then dropped to less than $8.00 in the dot-com bubble burst. The stock took three years to recover to its pre-crash price, and in the decade following its January 1, 2001 low, eBay rose 237% while the Dow Jones increased 10%.

Some will avoid Facebook due to the level of control Zuckerberg will exert. If that's a concern for a particular investor, then avoiding this stock will make sense, but those wary of the control Zuckerberg retains should note the success of other companies run by Founder CEOs. One study concluded that companies led by Founder CEOs outperformed others and found these firms “invest more in R&D, have higher capital expenditures, and make more focused mergers and acquisitions”

As with everything Zuckerberg touches, even the IPO is being done his way. What this all means is that those purchasing Facebook stock are not so much getting a share of the company as they are making a bet on Mark Zuckerberg. The IPO is carefully crafted to allow investors and employees to trade their shares on the market without altering the ironclad control held by Facebook's founder.

If you want a share of Zuckerberg's vision, you may wish to monitor the stock and jump in whenever you think the time and price are right. But if you do not share Zuckerberg's worldview or do not trust him, then there is nothing in the IPO filing that would suggest this is the stock for you. Even more than Jeff Bezos at Amazon or Marc Benioff at, an investment in Facebook is an investment in Mark Zuckerberg.

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Anonymous said...

I'd rather be a Facebook user (or advertiser) than a shareholder.

But I'm not shorting the stock, either...

Augie Ray said...

I agree--for now. There's (almost) always a time to buy into any stock. If only that time were evident! :)