BW Communities

Facebook Wants To Make An Offer You Can Refuse

BW Online Bureau Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[Facebook is organizing a party and is going to sell tickets to all of us. It is a party that we have been waiting to be invited to for a long time, but until now, it was restricted only to the company's founders, key employees and some fortunate investors who had been buying its restricted stocks.  We still do not know how much of the company will be sold, nor what the price per share will be. We do not know how markets will behave in the next months, since a depressed market could jeopardize the success of the IPO. But we do know that Zuckerberg and his team are selling us tickets worth about $5bn. But, isn't the fact that we are invited a clear sign that the party is not as fun as we thought it was? Two details make us wonder.  Firstly, we know that the objective of Facebook's IPO is not to raise funds to finance investments or repay debts. The firm is trying to create a liquid market for its employees, who are until now in possession of a very valuable asset which they cannot easily sell. Moreover, Facebook intends—after covering the tax liabilities arising from the conversion of stock options by Zuckerberg and colleagues—to keep most of the proceeds from the IPO in cash. That is, the worst possible use for money (putting it in a box). In the current economic environment where central banks print money only for it to freeze on bank balance sheets and where governments and international organizations are trying to make money move, here comes Facebook to sell us the possibility of storing our cash for good.  Secondly, creating a public market for inside shares may seem like a reasonable pursuit. Yet, there is a catch. Facebook has two share classes, A and B. Only A shares will be sold, but B shares are entitled to ten votes while A shares are entitled to one. After the IPO there will be about 117 million class-A shares, and 1,759 million class-B shares. Therefore, Facebook is selling a maximum of 6.2 per cent of the cash flow rights, and 0.66 per cent of the voting rights! We are sold admission to the party, but we cannot choose our own drinks.   Will the world be a better place after Facebook goes public? We surely hope so. However, the question should be: Whose world will be better? Well, certainly that of Zuckerberg and his associates, who will cash in their well-deserved millions of dollars. This is the reward for innovation, value creation, courage and hard work.  And there are the non-executive shareholders (mostly hedge funds) who have bought restricted Facebook stock in the pre-IPO market. Unfortunately that stock was only available for a few "sophisticated" investors: under SEC rules, only sophisticated investors (read: already wealthy) can purchase restricted stock (so probably, you did not get much of that action).  Finally, we have the investment banks. The IPO is underwritten by Morgan Stanley, JP Morgan and Goldman Sachs. If they follow the usual practice of charging 7 per cent of the IPO proceeds as a commission, they will share a $350 million prize for perhaps one year of work. Not bad. The underwriters have also reserved the possibility of an "over allotment option." This means that, if there are too many people willing to buy a ticket to the party, they will just print out more tickets (and get the 7 per cent commission of course). The typical over allotment option gives the underwriter the possibility to increase the number of shares by 15 per cent (that is, $52.5 million in additional compensation to the banks).  Of course the party goes on only to the extent that we, the potential shareholders, are willing to participate. But should we participate in the IPO?  Consider a lucky employee at Morgan Stanley trying to sell Facebook shares to her clients. How would she organize her selling strategy? She would probably start from her most prized customers, those whose acceptance would mean a high dollar amount for the IPO. If Plan A does not work, she will tap her next best customers, wealthy people who are potentially willing to put up a considerable amount of money. Finally, she will go down her list of clients starting from the third best and finishing up with … you and me.  When normal investors get the call, should we be happy? Not really. Chances are that there were reasons why the super rich passed on this "spectacular" opportunity: maybe it was not so spectacular after all! Could this be why we were asked to join? Think for a second: if it were such a great party full of celebrities and superstars, why would they be inviting us? This is not to say that the Facebook party is all together bad. But if we get an invitation, chances are that it won't be as much fun as we thought it would be. As Groucho Marx said, "I don't care to belong to any club that will have me as a member."  This party is not for us. (Professor Arturo Bris and Salvatore Cantale are professors of finance at IMD and teach on the Advanced Strategic Management and Building on Talent programs)