Facebook: 2nd quarter will fall short of expectations

The share price of Facebook does not exactly make a very good impression so far:

In one of the biggest IPOs in history, in which a huge amount of stock was sold to small investors, privileged Wall Street insiders once again got top-notch information...and individuals got the shaft.


Above is the conclusion from an article on BusinessInsider from Henry Blodget suggest that the reason for the weakness is that the 2nd quarter results will fall short of expectations, which was known only to a small group of insiders.


And now for some more bombshell news about the Facebook IPO...

Earlier, we reported that the analysts at Facebook's IPO underwriters had cut their estimates for the company in the middle of the IPO roadshow, a highly unusual and negative event.

What we didn't know was why.

Now we know.

The analysts cut their estimates because a Facebook executive who knew the business was weak told them to.

Put differently, the company basically pre-announced that its second quarter would fall short of analysts' estimates. But it only told the underwriter analysts about this.

The information about the estimate cut was then verbally conveyed to sophisticated institutional investors who were considering buying Facebook stock, but not to smaller investors.

The estimate cut appears to have influenced the investment decisions of at least some institutional investors, dampening their appetite for Facebook stock, and crucially, affecting the price at which they were willing to buy Facebook stock.

As I described earlier, at best, this "selective disclosure" of the estimate cut is grossly unfair to investors who bought Facebook stock on the IPO (or at any time since) and didn't know about it.

At worst, it's a violation of securities laws.


From a corporate governance point of view, Facebook is also not exactly a shining example, here is an excerpt from another article from BusinessInsider:


1. One-man majority rule: Zuckerberg holds 28.2 percent of the voting power ahead of the IPO, and he controls another 30.6 percent. That’s the majority he needs, although there are some restrictions, including the ability to vote for an issuance of stock that is more than 20 percent of what is outstanding already. Some of the voting rights end with the sale of the stock by its owners, the death of Zuckerberg or his giving up active management of Facebook.

2. The back-up plan: even if Zuckerberg loses or surrenders some control of his majority, Facebook continues to be heavily influenced by all owners of Class B shares. As long as these shares represent 9.1 percent of all shares outstanding, this group will control a majority of the votes. According to the S1: ‘This concentrated control will limit your ability to influence corporate matters for the foreseeable future.’

3. Board dependence: Facebook is taking the ‘controlled company’ exemption to corporate governance rules. As a controlled company, it won’t have to maintain a majority of independent directors on its board, and it won’t need to have a compensation committee or an independent nominating function. Zuckerberg’s designees have voting control, and if director Peter Thiel gives up his board seat, the board itself will decide who should fill it, increasing Zuckerberg’s control further.

4. Special situations: Facebook has taken specific measures to protect itself from acquisition. A transaction that would lead to a change in control of the company requires a majority of Class B votes (with these shareholders voting as a separate class). If Class B shareholders lose their overall majority, some ‘certain amendments to our restated certificate of incorporation or bylaws’ will call for a two-thirds majority of Class A and Class B shares. Simply put, the Class B shareholders – mostly founders and early employees – will retain majority control in certain situations with only a third of the votes. Also, when Class B shareholders lose their majority voting rights, the board will fill its own vacancies.

5. Meeting lock-down: what else happens when Class B shareholders lose their majority? Well, shareholders will only be able to ‘take action at a meeting of shareholders’, not by written consent. And only the CEO or a majority of the board can call a special meeting of shareholders – so any change would have to come with Zuckerberg’s consent.

While the corporate governance limitations at Facebook are not as seve re as those at the Carlyle Group, and the voting structure isn’t as favorable to Zuckerberg as Zynga’s, the net effect is straightforward: shareholders are surrendering themselves to Zuckerberg’s genius.