Opinion

Felix Salmon

Why Facebook won’t go public

By Felix Salmon
January 4, 2011

Miguel Helft explains why Facebook is going to have to go public sooner or later:

Mr. Zuckerberg’s quest to keep Facebook private will not last forever. Federal regulations require companies with 500 or more investors to disclose their financial results, eliminating one of the principal advantages of staying private.

This is a classic non sequitur: Helft’s first sentence simply doesn’t follow from his second. Yes, it’s nice for companies not to have to disclose their financial results. But just because you’re disclosing your financial results doesn’t mean you have to go public. Indeed, there are many privately-held companies which issue bonds and therefore disclose financials, but which have no public shares outstanding.

Follow Helft’s link, and you arrive at Steven Davidoff explaining the conventional wisdom in a bit more detail:

The company can still stay private even if it is forced to begin reporting to the S.E.C. However, in the case of Google, which faced with a similar choice several years ago, it chose to go public. Google decided that if it was going to have to release its nonpublic financial and other information to the S.E.C. and the public, it might as well get its bang for the buck and do it in connection with an I.P.O. Though not required to do so, Facebook would probably come to the same conclusion if the S.E.C. brings this reporting requirement to a head.

The problem is that I’m having a lot of difficulty working out what kind of “bang for the buck” Facebook would get from going public. Indeed, it seems to me that for Mark Zuckerberg, the downside of being public outweighs the upside, whether or not Facebook is reporting its financials to the SEC.

The main thing to remember here is that Zuckerberg is the CEO, he’s always wanted to be the CEO, and he has zero intention of relinquishing that job. He’s not like Larry Page and Sergei Brin, who are happy being founders and letting Eric Schmidt do the less pleasant things associated with being CEO: this is Zuckerberg’s company, and he’s going to run it.

The problem is it’s been hard enough for Zuckerberg to grow into being CEO of a private company: he’s certainly gone through quite a few executives along the way. The job of being CEO of a public company is very different, and much more outward-facing. For one thing, it involves lots of interaction with journalists and analysts. More invidiously, it involves being judged by share-price performance to the exclusion of almost everything else. Public shareholders have the right to demand that the CEO do his utmost to increase the value of their holdings from quarter to quarter and from year to year; it’s easy to see why Zuckerberg has no interest in bringing upon himself that kind of pressure.

It’s easy to see Zuckerberg being attracted to the idea of living like, say, Mike Bloomberg, running a multi-billion-dollar company exactly how he wants, without constantly being second-guessed. And remembering too the cautionary tale of Apple, where the founder, Steve Jobs, was forced out by angry shareholders when the stock failed to perform.

Of course, Zuckerberg does have shareholders right now, but he reports only to a very small board of directors comprising himself, Marc Andreessen, Jim Breyer, Don Graham, and Peter Thiel. Those are not the kind of people to care much about complaints from people who bought at a high valuation that they’re having difficulty selling their stake at a profit.

If Facebook remains situated at one remove from the harsh scrutiny of public markets, then, it’s likely to be able to follow its own path much more easily, without having enormous pressure to justify its $50 billion valuation with massive growth in revenues and profits. That’s probably attractive not only to Zuckerberg, but also to much of his executive team, and even to the board, none of whom to be in any hurry to exit their positions.

So why go public at all? The main reason for an IPO is to raise money, but Facebook has just demonstrated, in its deal with Goldman Sachs, that it’s more than capable of raising as much money as it needs privately. Any time Zuckerberg needs new equity capital, Goldman can find it for him at a very attractive valuation, no IPO required. And if Facebook is now profitable, it probably doesn’t need any more equity capital anyway.

The secondary reason for an IPO is to provide a mechanism for shareholders and early investors to sell their stake in the company. Again, Goldman will happily perform that role, acting as a broker between Facebook insiders looking to sell and its own high-net-worth clients looking to buy. No public listing required.

The final main reason for a public listing is to give the company an acquisition currency—but even without a public listing, Facebook is more than capable of offering to buy other companies with its own stock. It’s very rare for a private company to have stock which is as liquid and as easily valued as Facebook’s—but now that Facebook has got there, it doesn’t really need to go any further.

There are other reasons to go public, but none of them are very convincing in the case of Facebook: the idea that a public listing gives a company a higher profile, for instance, or that it expands the pool of possible shareholders, thereby increasing its valuation.

So my feeling is that insofar as Goldman has just bought itself Facebook’s IPO mandate, it might have bought a unicorn. Not that Goldman would mind in the slightest if Facebook stays private—right now, it’s in the highly enviable position of having the exclusive ability to parcel out Facebook shares to its own clients, and to make money on pretty much every trade in Facebook shares. That, surely, is more valuable than any one-off IPO fee.

Update: A couple of other things I forgot I wanted to say. Firstly, public shareholders tend to be a litigious bunch. And secondly, there’s a real chance that the Goldman-brokered secondary market will fall, rather than rise, in value from $50 a share. And there’s no chance of an IPO below $50 per share in the foreseeable future.

Comments
21 comments so far | RSS Comments RSS

The fiduciary obligation to private shareholders are pretty much identical to those of public companies. I don’t understand your point about corporate control. Especially when you consider they could do a Google-style IPO with all sorts of anti-takover, dual-share-class shenanigans to ensure that his cronies remain in control.

The reason why Bloomberg LP is run like Bloomberg’s fiefdom isn’t really because it is private but because he owns or controls the vast majority of the voting power.If Zuckerberg’s team can keep control then why would it matter if there are 500 shareholders or 500,000?

Posted by OneEyedMan | Report as abusive
 

“So why go public at all?”

It is worth noting that some tech companies were pushed into an earlier IPO because of the SEC requirement limiting the number of investors to 499. I am not so sure if that can happen in facebook’s case.

Posted by Chris_Gaun | Report as abusive
 

Does facebook pay a dividend? If so, that would also reduce the eagerness of shareholders for more liquidity.

Posted by dWj | Report as abusive
 

@ OneEyedMan: I had the same initial reaction, and it took me a little bit to figure out that there is a difference. That difference isn’t in the fiduciary duty owed, but the recourse the shareholders have. Public company shareholders can flee the stock fairly easy, so they have a pretty good remedy at hand and the CEO has a pretty strong incentive to listen to the shareholders. In the more illiquid private world, it’s not so easy to sell and the CEO has less reason to give a hoot about the shareholders’ wishes to maximize gains.

Posted by jpe12 | Report as abusive
 

Zuckerberg may not care about going public, but the other people who own 75% of the company will. It’s not like they are putting up billions just to let it sit there with no dividends and no way to realize gains. They will want their IPO.

But I’m not convinced they will go public for a different reason. Once their financials are revealed, their valuation will shrink. They allegedly had 500 million users as of July, and as an article in Fortune (http://finance.fortune.cnn.com/2011/01/ 04/five-reasons-why-im-not-buying-facebo ok/) points out, they haven’t announced any updated figures. But let’s say they have 600 million users right now, how many more can they add to that? Will they get users in China, Africa, India, or other countries that comprise almost half of the world’s population? I doubt it. I don’t even believe they have 500 million unique users (throw out multiple accounts and the ones that aren’t being used any more), but even if you accept that number, how do they increase their revenue and profits per user so much that they justify a $50 billion valuation? They can’t.

Most of the heavy FB users, the ones who generate all those page views the company’s publicists like to crow about, don’t have jobs. No jobs, no income, and no willingness from advertisers to pay a lot for ads. And when they do get jobs, they spend a lot less time refreshing their FB page. FB’s business model is not like Google’s, it is more like MySpace and AOL, and while they may be more successful at attracting users than those companies, they will end up being only a bigger version of them. They won’t be worth the $50B they are being valued at by Goldman (who doesn’t care, because they will be re-selling the FB shares just like they re-sold all those garbage sub-prime bonds, at a profit, to their all-too-trusting suckers, I mean, clients), nor will they be worth even $10 billion.

No, Facebook won’t be going public. If Zuckerberg proves to be smarter than Jerry Yang, they’ll get bought by Microsoft or some other desperate software/media/web company for $5 billion, if they’re lucky. Just wait a year or two and ignore all the fabulous twitter-like PR they are spinning. At some point their inability to translate teenagers’ escapes from reality and boredom into profits will be exposed.

Posted by OnTheTimes | Report as abusive
 

A really good analysis, Felix. I’m left wondering, however, why Zuckerberg doesn’t cash out. There’s a difference between being a phenomenon and a business with viable long-term prospects. I don’t know which category Facebook falls into but it seems a bit early in the game to completely deny that it might be a passing fad. Zuckerberg might be a genius but if he doesn’t monetize some of his investment then I’d be inclined to say that he needs to learn a thing or two about hedging bets.

Posted by TomLindmark | Report as abusive
 

And multi-millionaires investing their own personal money hating suing when they lose it?

Posted by Danny_Black | Report as abusive
 

Whoa, wait a minute… the price of investments can go DOWN as well as up? When did this start happening? Why was the public not informed? How can you just casually drop this bombshell of rampant Wall Street bankster fraudulent criminality in marketing products that are not guaranteed to always go up and give a higher than risk-free return with no risk? I can only assume The Man got to you to stop you publicising Da Troof.

Posted by Danny_Black | Report as abusive
 

@OnTheTimes, Don’t be so quick to say people who generate a lot of page views don’t have jobs. With mobile technology and applications people can view Facebook while at work. I know plenty of people who do so.

Posted by iflydaplanes | Report as abusive
 

what is this obsession about going public? he does not want to deal Wall Street. He does not want to deal with those research analysts (office monkeys). They read and make funky forecasts about your company and which create so much stress on management team… these people are trying to create business for themselves… going public is the stupidest decision a owner can make unless they need cash or an exit strategy… i love private companies… i love freedom and i love life without Wall Street people…

Posted by Ocala123456789 | Report as abusive
 

I agree that “public shareholders tend to be a litigious bunch,” and it makes me recall the advice of my Securities Regulation professor in law school to company founders (“never go public unless you want to cash out”), but, all that said, private companies can get sued just the same, like what happened to craigslist. See http://bit.ly/fJNGvI

Zuckerberg, moreover, has been more than willing to accept legal risks when need be. See http://bit.ly/gJF0ik

I have no doubt Zuckerberg wants to stay private as long as possible. The question is when his investors, particularly the ones on the board, start looking to cash out and so exert pressure on him to allow an IPO.

Posted by MaxKennerly | Report as abusive
 

Ocala123456789, Am glad that FB doesn’t need Wall Street, I guess Zuckerberg is talking up to 2bn from GSIP because he is bored.

Posted by Danny_Black | Report as abusive
 

@TomLindmark, no matter what happens to the value of Facebook stock, Zuckerberg will always be dynastically wealthy. He has no need to cash out.

Posted by FelixSalmon | Report as abusive
 

“right now, it’s in the highly enviable position of having the exclusive ability to parcel out Facebook shares to its own clients”

There are other companies that offer the ability to trade facebook shares.

Posted by themerv | Report as abusive
 

But … and this may be a very dumb question.

Aren’t all the people investing at this moment assuming that a $50 billion valuation is a bargain? What will drive a higher valuation — let’s limit it to the Goldman Sachs Golddiggers — that makes the investment savvy?

Can a relatively illiquid market (one open to only ultra-high net worth individuals) do that? Or are these new investors buying at what they hope will be pre-IPO bargain prices? Would they otherwise, i.e., would they put up $2 million to get a upside potential based solely on privately-reported earnings?

Sorry, that’s about 17 dumb questions.

Posted by johncabell | Report as abusive
 

An IPO would give Facebook a short-term cash infusion at the price of a long-term loss of control. If Facebook is a cash cow worth milking (and it is, though IMO the fifty billion figure is ridiculous), Zuckerberg and friends will be better off keeping the cow and selling the milk than selling half the cow.

Posted by Pedant | Report as abusive
 

As it stands GS and Facebook are colluding along with a limited number of private investors to claim that Facebook is worth 50bln. Isn’t it possible that an IPO would prove them wrong and the company is not worth what GS claims it is? There might be some enthusiasm at first but that could fade in the face of competition.

When these companies go under – their shareholders don’t have much in the way of tangible asset to liquidate do they? They are buying derivatives of an abstraction. Facebook is almost a virtual business with a few real offices.

If Facebook has significant office space it could be lease. But it seems that an internet company like Facebook could be run by employees who work from their own homes.

Posted by paintcan | Report as abusive
 

paintcan, how are they “colluding”?

Also you think many companies have market cap equal to their tangible assets? What do you think the “tangible assets” of Google are or Microsoft?

Posted by Danny_Black | Report as abusive
 

I think this valuation is somewhat reasonable. Zuckerberg reminds me a lot of Bill Gates. They also have similar products that have built themselves into the architecture of technology with network effects and economies of scale.

Facebook isn’t disappearing. Most users have hundreds of friends, large amounts of photographs stored on the site. Its difficult for them to en masse leave on social networking site for another so I think Facebook has staying power. And social networking sites have real value to people especially those who read sites like this who have studied abroad, worked abroad, gone to college far from home, moved around, etc etc. Its the easiest way to stay in touch at least a little bit with people that at one time were close associates/friends that you no longer can see on a regular basis.

I have no idea though on valuation as monetizing the site is still difficult. But they do have 500 million subscribers with a 50 billion market cap. If they can make $10/year/subscriber then this will be a 10 p/e.

Posted by sditulli | Report as abusive
 

I seriously doubt they have 500 million users… I bet most of those accounts are inactive.

Even if they do, I can’t see how they turn that into $10/year of revenue.

Finally, their expenses are significant. They would need more than $5B in revenue to justify a $50B market cap.

Posted by TFF | Report as abusive
 

@OnTheTimes I believe you think that Facebook has a static business model by sticking with just social media. If your assumption is correct, I agree with you. However, I believe Social Media is just their entry point into the enterprise, much like how Google and Yahoo used search to get there. Just look at how Facebook is already expanding their reach simply by pushing their single sign on brand to sites even like Reuters. For that reason it is understandable why he is so upset with Sean Parker for wanting to ditch Facebook’s exclusive login rights to Spotify and its music. No I think Zuckerberg has much bigger plans and I think he has the goods to go after Google and even Google knows it.

Posted by Vijit | Report as abusive
 

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