Facebook is a corporate dictatorship…

A fab interview by Aswath Damodaran on the  Facebook IPO debacle.  (Here is another Wharton article discussing the (de)famed IPO)

He has been dissecting the FB valuation for a while now on his super blog (each post is like a mini paper with so much to understand). As per him the value of FB was $29 per share and was obviously over-valued in the IPO. (He says this wasn’t valued but priced).

In this interview he pretty much discusses all he has been saying on FB IPO:

Let us start with Facebook. You have been critical about their IPO pricing.
The trouble with Facebook is figuring out first what business they are going to be in, because they haven’t figured it out themselves. How are they going to convert a billion users into revenues and income?And second, if they even manage to do it, how much those revenues will be, what will be the margins, et cetera. They don’t know how they are going to make money. Are they going to sell advertising to these users? Are they going to sell products to these users? Services to these users? I think all they know right now is that they have a lot of users.

But if they have no idea of what to do with their users, how did they make the $4 billion in sales that they did last year? 
They are selling. 12% of that came from selling stuff for Zynga (The maker of popular games such as “FarmVille” and “CityVille,”). The remaining 88% did come from very subtle advertising. The question is, can they scale that up? Because, right now, it is kind of invisible.

You can’t see it because it is relatively small. But if they want to generate the kind of revenues they want, you are going to see it on your Facebook page. And it is going to be very clear that they are using what they know about you to pick those ads. And I am not sure people will be comfortable with that, knowing that they are seeing not just your profile but your interactions. So they can see how old you are.What political party you support, what sports you like, it is all going to go. And that’s their selling point.

Compared to Google:

How does it compare with Google? 
In case of Google it is a much more direct business model. It’s search. You click and that’s it, everybody could see what they were doing. Facebook is a much more subtle model. On Facebook, you are talking to your friends, which is a private conversation between you and your friends, but when you see these intrusive ads on the side, you realise you are not just talking to your friends. You are talking to your friends and somebody at Facebook is monitoring you at the same time. That’s a very tricky challenge. So they have made the $4 billion, but at the value (the market capitalisation of the Facebook stock) they have, they have to make $35 billion. And that’s a very different game because that would mean a lot more ads on every page directly focused on what the users are doing.

Apart from valuation bit, he discusses how Google started this trend of non-voting shares. Success of Google has made a lot of difference in the way these companies are being run. You now have a situation where someone can own lesser % of shares but still have larger voting power:

Until Google came along, US companies generally did not have two classes of shares. Voting shares and non-voting shares were for a long time banned by the New York Stock Exchange (NYSE). So, most companies didn’t even try. So, if you look at Apple, you look at Microsoft, they had only one class of shares. Google essentially did two things. They did their IPO through an auction rather than through investment banks. And secondly, they decided to have voting and non-voting shares. If institutional investors had risen at that point in time and said we are not buying these shares because we don’t have enough voting rights, then Google would have been forced to go back to drawing board and then come back. Institutional investors were okay with Google doing that.

Once they opened that door, every social media company you look at — LinkedIn and Groupon — they follow what Google did.

So these shares are listed on Nasdaq? 

Yes. Nasdaq allows for voting and non-voting shares that is the part of the reason for listing on it. The NYSE because it is in competition with Nasdaq has now also started relaxing, they want the money, they want the listings. So they will take Facebook even if it’s voting and non-voting shares. So, this will be a race to the bottom.

As a result, FB runs like a dictatorship with Zuckerberg calling the shots:

You have said in the past that Facebook has huge corporate governance issues. Can you elaborate on that?

It has got voting shares and non-voting shares. Zuckerberg has got the voting rights. It is also incorporated as a controlled corporation which basically means that you don’t have to follow the corporate governance rules (like the Sarbanes Oxley Act) that publicly traded companies need to do. They can have insiders on the board.

Is that allowed?

If you are controlled corporation, it is. And Facebook has been very open about that they are going to be a controlled corporation.

How does regulation allow for something like that?

As long as you make it public. If it is a controlled corporation, investors have to make a judgement as to whether they care. In case of Facebook, initially it looked like they didn’t care. Right from the beginning, Facebook has been very open that they are not really going to be a publicly traded company and that really they are a private business that wants the capital that public markets give them. But it is going to be Zuckerberg’s company.

So they won’t give out much information?

They might give out the information but you will have no say in what they do. So if they do an acquisition…

Did they overpay for Instagram?

They paid. I don’t know whether they overpaid. But they paid and there was no accountability. Zuckerberg basically decided to pay a billion (dollars), then he told the board that I have bought the company and I have paid a billion. This is not the way a company should be bought. A CEO shouldn’t be deciding what to pay overnight and you shouldn’t be telling the board of directors after you have bought a company that I just bought a company for a billion and I just want you to know.

This is like how mom-and-pop shops down the road operate… It is a way a dictatorship operates. Facebook is a corporate dictatorship.

Very interesting. Did not really know much about this..

So unless Zuckerberg decides to sell voting shares, he can continue to make and dictate: decisions

So, the shares sold to the public were non-voting shares?

They are low voting shares. The shares that Zuckerberg owns have ten times the voting rights, which means he has 57% of voting rights with 35% of the shares. And he will always make sure that remains above 50%.

So he can go ahead and buy anything without requiring clearance from the board?

Google, for instance, recently issued new shares which have no voting right at all. So, that is the third layer. You have ten voting rights shares. One voting rights shares. And no voting rights shares. Zuckerberg can go out and raise as much capital as he wants. If he issues no voting rights he will always have 57%. He is going to lock in that voting percentage.

So should these dual voting shares be banned? Nopes. Damodaran feels let investors pay the price for the choice they make:

But how is something like this allowed in a developed market like the US?

I don’t think it should be banned. Let the investors decide for themselves. In several countries, you have two classes of shares. It’s par for the course. And you just price it in.

It’s just that it hasn’t happened in the US for a long time?

I think you will wake up one day and see I wish I had voting rights. But you chose to be a part of this game. I am not feeling sorry for the institutional investors in Google who are crying about the fact that Google does things they don’t like. You bought the stock, you live with it.

Amazing insights on FB..


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