How companies should take advantage of markets

By Felix Salmon
December 20, 2013

I like Matt Levine’s dry take on Facebook’s secondary offering: “Whatever else you think of Facebook,” he writes, “it is unusual among public companies in its desire and ability to sell stock at local maximums.” And really, he’s right: it makes perfect sense for a company (and its controlling shareholder) to sell stock when demand is greatest and the price is at its highest. After all, share sales are a simple transaction: you give me a one-off slug of cash today, and in return I’ll give you ownership rights in perpetuity. Anybody engaging in such a deal should at least want to maximize the amount of cash they’re getting, which is another way of saying that you should only sell stock if you think it’s overvalued.

On the other hand, I don’t buy Cyrus Sanati’s criticism of the deal, which is that Facebook shouldn’t be diluting its shareholders like this when it already has more than enough cash on hand — and is profitable, to boot. But let’s put this “dilution” into perspective, here. For one thing, the 27 million shares that Facebook is selling to the broad public constitute less than half of the 60 million new shares that Facebook is issuing to Mark Zuckerberg personally, as part of its most recent options grant. If you want to complain about dilution, then complain about the options, not the secondary. And in any case, before this deal (and before the options grant), Facebook had 2,458,051,029 shares of stock outstanding. Which means that the new stock being issued by Facebook is dilutive to the tune of just under 1.1%. In a world where Facebook stock has doubled in the past five months, that’s really nothing.

The real news here is that Zuckerberg has finally started cashing out in a very big way. While he did sell some stock in the IPO he only really sold enough to cover his personal tax bill; in this deal, however, he’s selling 41,350,000 shares — which is significantly more than the amount he would need to sell to cover the taxes on his latest options grant. And by “significantly” I mean one billion dollars net after taxes. That billion dollars in cash is over and above the other billion dollars he’s giving to charity in the form of Facebook stock, which will have the pleasant side effect of reducing his annual taxable income by exactly the same amount.

Interestingly, for all that Zuckerberg is selling $3.3 billion of stock as part of this offering, his control of the company is greater now than it was before the IPO: back then he controlled 56.9% of the total voting power in Facebook, while after this deal he’s going to control 62.8%.

It seems to me, then, that the real way to look at this deal is to remember that Facebook is Zuckerberg’s company, and that drawing distinctions between the two is not very helpful. Zuckerberg wants to diversify his wealth out of Facebook, and he’s doing that now. He also knows — almost better than anybody else on the planet — just how quickly large technology companies can get disrupted. After all, he did that himself. So he wants Facebook to have a very large warchest of cash, which he can then use to acquire the kind of fast-growing, mobile-native products which threaten to make him obsolete. And right now is a great time to amass such a warchest: Facebook is being added to the S&P 500, which means that lots of index funds want to buy his stock. That kind of permanent step-change in demand for Facebook stock can easily justify a small step-change in the number of Facebook shares outstanding.

Or, to put it another way: three years ago, Facebook could entice talented engineers away from Google by promising them lots of Facebook stock, on the grounds that one day, Facebook would be a $100 billion company and they would be rich. Now, however, Facebook is a $100 billion company. (To be precise, it’s a $135 billion company.) As a result, its stock is much less attractive to someone looking for massive appreciation in the next few years: you’re much more likely to go from $30 billion to $120 billion than you are to go from $125 billion to $500 billion. Which in turn means that Mark Zuckerberg has moved on, and is now offering cash, rather than stock, to the companies and individuals he really covets. (The $3 billion he offered for Snapchat is an enormous amount of money, but it’s a lot less than the $10 billion of cash that Facebook currently has on its books, gathering dust.)

Zuckerberg has made a determination that he wants a lot of cash, both for himself and for Facebook, and that it’s worth selling a few shares in the company in order to get it. That doesn’t, pace Sanati, mean that Zuckerberg thinks Facebook is overvalued. It just means that there’s a cycle to these things. Facebook already has a large market capitalization; having a large market capitalization and billions of dollars in cash gives you more power and more optionality.

Who’s at the other end of the cycle? Which firm is currently most similar to Facebook circa 2010, looking to attract talent by giving out equity? The answer is Square, where Jack Dorsey has given back 10% of his shares, just so that the company can attract the very best talent going forwards. That’s smart. Dorsey doesn’t need the money: what he’s looking for is growth. If Dorsey needs cash, he can always sell some of his Twitter shares, which are currently valued at well over a billion dollars. But if he wants to attract Silicon Valley engineers who dream of becoming dynastically wealthy on the day of an IPO, then right now he needs to be able to hand out significant chunks of stock.

What Zuckerberg and Dorsey have in common is that they’re taking full advantage of the astonishing valuations which can be bestowed on companies — and their shareholding employees — by public markets. Zuckerberg is tapping those markets for cash; Dorsey is pointing to their potential. This is a really good thing: this is what markets are for. Markets provide incentives, and the owners of companies take advantage of those incentives. Shareholders shouldn’t want to have it any other way. Even if certain index-fund managers feel a bit as though they’re being dragooned into shipping billions of dollars over to Mark Zuckerberg, right at the point at which the stock hits an all-time high.

Comments
5 comments so far

minor nitpicking, Felix: I believe you link to Zuck’s % ownership is from the IPO filing – outdated.

check this one:
http://www.sec.gov/Archives/edgar/data/1 326801/000119312513478298/d646653ds3asr. htm#toc646653_6

which shows that his total control is going from 65.2% to 62.8% if I’m reading it right…

Posted by KidDynamite | Report as abusive

From the least cynical possible standpoint, while “cost of equity” is hard to measure, it surely is lower when the price of stock is high than when it’s low; investment opportunities (let’s include in that “liquidity buffers”) that aren’t attractive when cost of funds is high become attractive when cost of funds drops. Facebook doesn’t have to be trying to time the market; if they have some consistent way of estimating how much equity they want as a function of its cost (better yet, directly as a function of the stock price), they end up “buying low” and “selling high” just by trying to reoptimize from time to time.

Posted by dWj | Report as abusive

@Kid — The new filing does show Zuck’s control going down when he sells his 41 million shares. But it’s still higher than it was before the IPO. And it’s still higher than it was before he got his latest 60 million share stock grant, which is included in the 65.2% figure.

Posted by FelixSalmon | Report as abusive

I was really hoping that either Matt Levine or Felix would reference this Steve Wynn quote from almost 6 years ago – http://longorshortcapital.com/translatin g-corporate-speak-wynn-unforseen-upside- edition.htm

Posted by realist50 | Report as abusive

Does Zuckerberg use 10b5 plan to sell his stock? If so, how does he time his sales based on stick price? If not, how is it not insider trading?

Posted by AngryInCali | Report as abusive
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