Dual class shares: another really bad idea (2)

I wrote before about this issue.

Proponents of Dual class shares often point a some US companies that have dual class shares and are doing quite well. One of the companies mentioned is Facebook.

May be those people should read the following article from Bloomberg:

Facebook's Investors Criticize Marc Andreessen for Conflict of Interest

One snippet:


Earlier this year, Facebook Inc.'s Mark Zuckerberg came to his shareholders with a big question: would they approve him maintaining voting control of the company, even if he sells most of his stock?

The monumental shift would benefit Zuckerberg because it would let him sell shares to fund philanthropy, but it had the potential to harm investors by diluting their power over decision making. And before putting the vote to shareholders, Facebook's board had the power to influence the outcome.

But the board's process was flawed, according to investor lawsuits filed against Facebook's directors in April and recently unsealed court filings in Delaware's Chancery Court. The company went through the motions of protecting minority shareholders, but one board member seemed more interested in protecting Zuckerberg himself, investors allege.

Zuckerberg has voting control among shareholders because his stock has most of the voting rights. He wanted to sell shares, but didn't want to lose his majority voting status. So he proposed setting up a new Facebook stock class. The new shares would automatically dilute the voting power of existing shareholders, because every share with voting power will split into three shares -- one that has power, and two that don't. In the new arrangement, the non-voting shares are less attractive as currency in acquisitions and may make it harder for the largest social-network provider to get tax benefits, among other issues. 

The question was put to a vote by shareholders, but there was never any doubt about the result. Since Zuckerberg has majority voting control of the company, what he favors wins the day. Zuckerberg's proposal won the vote, and he got his way: He can sell his stock and maintain voting control. The shareholders approved the creation of a new stock class. The only entity that had any power to affect the outcome was Facebook’s board, which had already weighed the issue months earlier, in his favor. 

In August 2015, with the chief executive's blessing, Facebook's board set up a special committee, choosing the three directors who were least beholden to Zuckerberg or financially affected by the decision -- Susan Desmond-Hellmann, Marc Andreessen and Erskine Bowles -- to represent shareholders while weighing the matter, according to a regulatory filing.

But Andreessen, a venture capitalist at Andreessen Horowitz and a long-time Facebook board member, is a close Zuckerberg ally. While on the committee, Andreessen slipped Zuckerberg information about their progress and concerns, helping Zuckerberg negotiate against them, according to court documents. The documents include the transcripts of private texts between the two men, revealing the inner workings of the board of directors at a pivotal time for Facebook. 


David Webb wrote about this:


Awful corporate governance at Facebook. Zuckerberg pushed through a scheme to create and distribute non-voting Class-C shares so that he can further reduce his investment without losing voting control. A so-called "independent committee" of 3 directors was established, including Andreessen, who secretly coached Zuckerberg on how to deal with them. Then he gets to vote it through at the shareholder meeting anyway.    

One could argue that at least some shareholders took action: "The plaintiffs suing Facebook's board include pension funds, like the Employee Retirement System for the city of Providence, Rhode Island, and individual investors."

But how much chance is there that the same will happen in Singapore (or Malaysia for that matter)? I think almost none.

Zuckerberg cameo

Accidental appearance of Marc Zuckerberg and Priscilla Chan in this Chinese documentary, about 30 seconds in the clip. Shanghai has a population of about 23 million, so what are the odds of this to happen?

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.

Is Facebook a Bubble?

Friday, finally, after much hype, Facebook was listed on the Nasdaq. After (rather embarrassing) initial technical problems the stock ended where it started: at around $38, its IPO price. Rather disappointing for a much touted tech stock.

The IPO turned many employees in millonaires and multi-millonaires and some into billonaires or even multi-billionaires. And Singapore has one more very rich resident since 2009: co-founder Eduardo Saverin.

Dan Ariely, writer of well known books like The Upside of Irrationality and The Honest Truth About Dishonesty, writes about the fees that Morgan Stanley and the like make on the IPO. He estimates it at $ 660 million of investment bank profits. However, friendly parties who receive the IPO shares might make more money (although with hindsight not that much, since the stock traded only a few dollars above its IPO price).

At $38 the market cap of Facebook is $108 Billion, giving it a PE of about 108. Priced to perfection, not leaving any room for disappointments down the road.

With close to 1 Billion users currently, there is still some growth left. However, in a country like China Facebook is simply barred (Tencent is the leading player), so that is already 1 Billion potential users less. And a country like Japan has its own, highly successful social/gaming websites (GREE and DeNA).

Well known Professor Damodaran finds Facebook overvalued:

I think that the hype is overdone, that disappointment will set in sooner or later and that the stock has far more downside than upside. You can put me in the last group (long term sell) though I am still searching for the most efficient (and least costly) way to execute this.

Facebook, in spite of its ubiquitous presence in our lives, is just one company and not a very big one (at least in terms of revenues and earnings) yet. The market will obsess about it tomorrow but it will move on very quickly to the next worry, fear or fad.  

The New York Times made this graph, to put things in perspective versus previous tech IPO's:

There have been similar companies that faded in history, MySpace comes to mind.

On the other hand, the company is now cash rich, and can use its sky high shares for acquisitions. That is what Cisco did for a long time in the nineties, and got away with its high valuation for many years:

But in the long run the valuation came down and it could not play the acquisition game anymore. People who bought the stock around 2000 and held on to it will not be happy lot.