Facebook: The smart money exits

By Felix Salmon
May 16, 2012
$18 billion.

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The Facebook IPO is now set to raise an absolutely astonishing amount of money — as much as $18 billion, if the greenshoe is exercised and the offering prices at the top of the indicated range. As a result, it’s certain to be the single largest technology IPO of all time. (Most companies don’t even have a valuation of $18 billion when they IPO, let alone have $18 billion worth of stock for sale to the public.)

So what is Facebook going to do with all that money? Well, it turns out that in upsizing the size of the IPO, Facebook has not actually increased the number of shares it’s selling to the public. Instead, most of the new shares being sold are coming from Mark Zuckerberg personally. He’s now going to sell 126 million shares in the IPO, and other early investors, including James Breyer and Peter Thiel, are cashing out too.

I’ll do the math for you: 126 million shares, at $38 a piece, comes to almost $5 billion. That’s a lot of money to raise in one day. When Facebook first filed for an IPO, Zuckerberg was only selling enough shares to allow him to pay what will probably be the single largest individual tax bill the IRS has ever seen. But now, Zuckerberg’s going to be a billionaire excluding his Facebook stake.*

More generally, this seems to be the point at which the smart money is getting out of Facebook. Accel Partners is now selling 49 million shares in the IPO (think $1.8 billion), while DST and Mail.Ru will sell some $2.5 billion of stock in total.

Capital markets are not particularly efficient, but one thing nearly always holds true: when stock prices are high, companies issue more stock, and when stock prices are low, they issue less stock. In general, we’re not seeing a huge number of primary or secondary offerings right now: it’s still cheaper for companies to issue debt rather than equity. The exception, of course, is in technology companies, where it’s clearly possible to go public at frothy multiples — even if those IPO valuations don’t last long.

The Facebook strategy is an interesting one: a lot of the time, in technology IPOs, you see companies issuing a pretty tiny number of shares, and using artificial scarcity to boost the price. That’s definitely not happening here — Facebook stock is going to be a highly-liquid price discovery tool from day one. And if there are lots of institutional investors out there wanting to own a piece of Facebook at a $100 billion valuation, then frankly you can’t blame Zuckerberg and Accel and DST for taking them up on their offer.

But it’s worth remembering, here, that the main reason that Facebook is going public at all is that it has more than 500 shareholders — and the reason it has more than 500 shareholders is because early investors, including Accel and DST, have been selling down their stakes in private markets for some years now. The main difference between the public markets and the private markets is not the valuations available — $100 billion is very much in line with where Facebook stock has been trading privately — but rather in the sheer volume of stock that can be efficiently sold at one time.

When this IPO is over, Zuckerberg will still have complete control over the company, with more than 50% of the voting rights. But his new shareholders will look very different from his old shareholders, even if the board remains the same. And by far the biggest difference is that while the old shareholders were all sitting on monster paper profits, on their Facebook stock, the new shareholders won’t be. They’re going to want to see the share price — and Facebook’s valuation — go up, substantially. Which means that they’re going to want Zuckerberg to come up with a plan to make Facebook worth $200 billion, or $300 billion, or more.

In order to do that, it’s not going to be enough for Zuckerberg to build a platform: he’s going to have to monetize it, to the tune of way more than a billion dollars a year in advertising profits. Facebook, right now, is trading on its potential for making future profits. At some point, and it’s not all that far away, Zuckerberg’s going to have to realize that potential. Or face some extremely angry shareholders asking whether he played them for suckers when he sold those 126 million shares.

*Update: It now seems that the extra shares being sold by Mark Zuckerberg are not shares he owns, but rather shares he doesn’t own. Zuckerberg has an “irrevocable proxy” over certain shares, which means that he controls them without owning them. He seems to be selling those shares, not shares he owns pesrsonally. So he won’t personally receive the extra billions.

18 comments

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And the extremely angry shareholders will say, “We’re extremely angry!” And Zuckerberg will say, “and so what? I control the company. And did you notice? I have a billion dollars in cash. Lose my phone number.”

Posted by johnhhaskell | Report as abusive

Frankly, I say kudos to Zuckerberg for making the capitalist system work for him instead of the plutocracy. The shareholder/voting rights structure is going to allow him to do what he wants to do without even the slightest regard for activist shareholder hedge funds; he’ll avoid what’s happening to Yahoo with ThirdPoint.

Posted by Strych09 | Report as abusive

Remember all of those other apps that you don’t hear about; remember MySpace?

There are no barriers to entry here, and someone will soon exploit that weakness.

Posted by MikeStover | Report as abusive

“the main reason that Facebook is going public at all is that it has more than 500 shareholders”

well, maybe originally that might have been the case, but given that Zuckerberg and some large investors are selling huge stakes, that’s not true any more. They don’t have to sell all those shares, but they’re not holding on to them. FB is going public because some large shareholders want to cash in.

Posted by KenG_CA | Report as abusive

But, but – if everybody loves it, how can it be wrong?

Posted by MrRFox | Report as abusive

I would not go anywhere near this IPO… Let the fools be parted with their money

Posted by GA_Chris | Report as abusive

I think you’ve misunderstood the numbers. This is from the SEC filing:

“We expect that substantially all of the net proceeds Zuckerberg will receive upon such sale will be used to satisfy taxes that he will incur upon his exercise of an outstanding stock option to purchase 120,000,000 shares”

Notice that it says “to purchase”. That $5B in gains isn’t a $5B liquidation; it’s a $5B exercise, creating a $1.7B tax liability. Zuckerberg is liquidating a small amount of his Facebook stock so that he can buy even more of it. That doesn’t sound like someone who is “playing [buyers] for suckers” to me.

I also think you’re reading too much into VCs cashing out at IPO. That’s reasonable for them to do even if they think Facebook will continue to succeed. VC funds are also not in the business of public stock markets – they want to invest in smaller companies with greater growth potential. It’s also worth noting that most funds operate on 10 year schedules, so it might be time for the early guys to pay back their investors.

Posted by Anonymous | Report as abusive

Facebook is a great product, platform and will generate lots of revenue; its used in almost every household and most people like it. Its a VERY valuable brand…but $100 billion? The author is correct – the only way they can get a return is to destroy the user experience with ways to make money (more adverts, user fees, event fees, etc, etc). And then they risk competitors coming in. Lets not forget Google already has a what I think is a better social networking tool that I and others simply dont use but for one reason – everyone else is on Facebook.

Posted by John2244 | Report as abusive

Well good luck to people who buy this, but I wouldn’t go anywhere near it. The valuation is just stupid given the downside risk and given that I haven’t heard anything about how Zuck intends to triple the valuation.

Furthermore, I’ve advertised a lot on Facebook and I can tell you, firsthand, I have no idea how he’s going to pull even CLOSE to what Google does. There are many reasons for this (some which I won’t state publicly but I encourage you to try advertising) but I’ll state one iron-clad observation:

I own a small business on the side. I have a VERY successful Facebook page. If I advertised on it at all, I mean in any overt way, it would die. It’s all about providing a social area for people, NOT to directly advertise to them. That’s why it’s so successful. I know no one clicks on the ads and that they hate them. If there were more it would kill off the page, and I’d start looking for another venue. I’m sure I’m not alone. Remember this observation by a close friend of mine: Having a Facebook business page (or even your own) is like throwing a cocktail party. People come by, talk for a while, comment, then they move to the next small party. Anything interfering with this will kill the experience. Unless Zuck knows something he’s not saying I don’t think he knows a way around this. In fact, I’m going to say there IS no way around this. So the paradox here is any attempt to monetize the user experience will take away value. And if there were any charges for the site, Google would never charge and clean house and so would the next company to produce a site. So in the end, what justifies the valuation or an “investment”?

Posted by skyman123 | Report as abusive

Personal anecdote. Both my wife and I went full in with Facebook a couple of years ago with all that that means — “friends” and reconnecting with lots of people we had forgotten about years ago. For a while it became the equivalent of the old slide show for us. Hey, look, what we did on vacation, Hey, look what we did last night, Hey, the kid’s taken up the saxophone, Hey, I lost fifteen pounds, Hey, where’s a good place to eat in your town, Hey, I got a promotion, Hey, isn’t this a great song? etc. The truth is, after a while it became obvious that most of the people we know or knew are boring as hell. And the rubbish they would send us to look at! Bit by bit we got tired of the whole shtick and checked in on it less and less often. I haven’t bothered to look at any of the Facebook junk clogging my inbox in months. And forget clicking on ads. No way. So, I guess my point is, are we the only ones who feel this way? Sure, Facebook may have 800 million accounts but how many of those are active? I’ll wager far fewer than Zuckerberg would ever admit to.

Posted by IntoTheTardis | Report as abusive

I’m no Facebook fan, but I think these comments are misguided.

On the investor side, the issue is not an assumption that Facebook WILL make money, it’s an assumption that Facebook MIGHT be the next Google. This sort of bet is likely dumb for an individual investor, but makes sense as part of a broad portfolio.

On the money-making side, Facebook has done a pretty good job so far of continually seeing itself not as “your personal web page” or “your personal web page + email replacement” or “your personal web page + email replacement + photo-sharing”. They keep expanding their ambitions — basically anything that involves your interaction with other human beings they see as part of their remit. It seems awfully foolish to assume that this is not something monetizable (and not only through ads). Throughout history people have been willing to pay good money to communicate. Facebook today extends that trend in ever more abstract ways — look at their being really the first federated ID system to take off on the internet.

How could they make more money? Some obvious examples

- get into the same sort of business as Skype — offer voice and phone calls and charge for extra features

- get into the same business as Dropbox — provide the basic photo/video sharing they have now, but charge money for more than a certain amount of storage

- get into the same business as Pandora/Netflix — provide ways to share music and video between friends and charge for the experience. Eg — synchronized movie viewing — we all see the movie together in sync, but on widely separated screens, there’s a backchannel (text or voice chat for us to comment and make snyde remarks), when one of us pauses for a bathroom break, the movie pauses for everyone.

- get into the same business as Amazon Prime — offer an annual membership fee which provides all the above benefits and continually adds more.

To assume that Facebook HAS to make money by serving up more and more obtrusive ads (with the inevitable result that they will drive users away) is really limited thinking.

Posted by handleym | Report as abusive

handleym- I don’t see any of those examples as obvious ways of making money- they all involve Facebook attempting to start an entirely different business (businesses which, as you so kindly pointed out, already have competitors which tremendous market shares). Maybe I’m crazy, but I think its more reasonable to value Facebook based on the business it is currently in, not new businesses that it might enter. And as everyone here realizes, the business that they are currently in, while it has value, is not anywhere near the insane valuations people seem prepared to buy its stock at.

Posted by AdamJ23 | Report as abusive

AdamJ23 — your post is an example of my point.

You think Facebook is in the “blue web pages” business. I am pointing out that it is not — it is in the “human(s) to human(s) communications” business, and that is a huge business. Each of the examples I gave is, yes, competing with an existing business — but the assumption is that Facebook can leverage what it already has to do the job better.

Consider my communal movie watching example — yes in theory you can cobble together something like that with NetFlix or Amazon or iTunes. But Facebook is the guy that can write, on Joe’s page: “Joe is currently watching (and mercilessly mocking) ‘Green Lantern’ with Bill, Mike and Sue — do you want to join them?” And this will work, because Joe’s, Bill’s, Mike’s and Sue’s friends are all already in the habit of looking at Facebook pages to see what their friends are doing.

A bet of Facebook is a bet on
- people will find ever more ways to interact with friends via the internet
- Facebook will do an adequate job of supporting these new interaction modalities
- competitors will not do as good a job.

I’d say history so far bears out all three of these assumptions.
(The third might be controversial, but Google+ is struggling, Ping is basically dead, and Twitter, while successful, does not have the history of growing its vision and cope like Facebook has.

The dark horse COULD be Skype. But MS is so paralyzed with internal empire building and civil wars that it seems unlikely that they will ever get their act together enough to unite their Skype users, XBox Live users, and all their various other network property users into a single social network — heck they can’t even get their act together on a single branding strategy for all these properties.

Apple is the other dark horse. They have the single userID sorted out, and have access to part of the social graph through iChat and FaceTime. What’s not clear is if they are even much interested in this space — they tend to be very focussed and to ignore areas where they don’t have any obvious advantage.)

Posted by handleym | Report as abusive

A combination of what skyman123 says “any attempt to monetize the user experience will take away value” and IntoTheTardis says “after a while it became obvious that most of the people we know or knew are boring as hell”.

The need to monetize users has through advertising has already been thoroughly analyzed, but I think most people are underestimating the fact that there is a limit to how much people want to interact with their friends. Continuously updating your Facebook profile takes both time and energy, something that for most people is already in short supply. Nevermind the time and energy it takes to keep up with all your friends on Facebook as well.

Right now I would guess that a huge portion of Facebook’s users are single and not in the workforce (either because they’re in college or unemployed)…i.e. people with a lot of free time. However, as they get married, get jobs, and have kids, a lot of that free time will disappear, and the amount of time they have available to spend on Facebook will decrease.

Most people forget that Facebook, by virture of being dependent on its’ users to generate content, is up against two of the most immutable forces in nature…laziness and entropy.

Posted by mfw13 | Report as abusive

We admit that a lot of what we learned in business school hasn’t stood the test of time. Debt isn’t cheaper than equity. And there really is no risk-free security.

But one thing we’re sure is right is this: when the insiders are selling — and, boy, they sure are selling this piece of you-know-what — the stock is over-valued.

Insiders cashing out? All we can hope is that they spend a lot of the next several years giving fraud depositions and defense testimony. They are fleecing the public — the same fools who made this time-sink so popular. We love the irony.

Posted by WeWereWallSt | Report as abusive

Its all hype. Only suckers believe the hype. GM has already pulled out advertising. More to come when they see the returns are just not there. GM is a great beacon because the company has to be frugal with its expenditures considering it returned from the grave not so long ago.

Posted by gyris | Report as abusive

I’m avoiding this like the plague. This is 100% hype. The only people who will make money are the insiders who are cashing out. Fools rush in where angels fear to tread.

Posted by MaryWilbur | Report as abusive

Mr.Zuckerberg made out like a pirate in a black hoodie, good for him, but its looks like the cats finally out of the bag for Facebook stock, as for it being hype, the whole stock market exchange is built on hype or chance

Posted by running | Report as abusive