Facebook isn’t the worst example of financial shenanigans that need investigation by the SEC, but I’ve chosen to give it attention recently, because the general public can easily understand the mechanics of a stock pump and dump.
Facebook’s underwriters currently face allegations that at its May 2012 initial public offering (IPO), they gave downward earnings guidance to select investors while other investors were uninformed. Giving downward earnings guidance during an IPO is alarming and extremely rare. Facebook’s insiders and officers sold stock.
As I’ve mentioned before, Facebook officers have been selling stock this past month, but that should mean that none of them had knowledge of Facebook’s negotiations with Zynga. Perhaps Mark Zuckerberg handled the negotiations himself, because meanwhile, Facebook and games-maker Zynga have been revising the terms of a five-year deal they struck in 2010 to make the terms more favourable to Zynga.
Now newly launched Zynga.com won’t have to use Facebook as the only way for gamers to log in. Moreover, Facebook took 30% of Zynga’s sales through Facebook’s virtual payment system via Facebook ads, but now Zynga.com isn’t obliged to use Facebook’s system. Facebook will still get a new game at the same time as, or shortly after, Zynga launches it elsewhere, but Zynga isn’t require to use Facebook as its non-Zynga platform.
The contract negotiation was material insider information. How do I know this is material information? Facebook told us so. In its 10-Q for the period ending 9/30/12 and filed with the SEC on 10/24/12, Facebook stated the following in original bold italicized letters:
In the first nine months of 2012 and the full 2011 year, we estimate that up to 13% and 19% of our revenue, respectively, was derived from Payments processing fees from Zynga, direct advertising from Zynga, revenue from third parties for ads shown on pages generated by Zynga apps, and Facebook ads and Sponsored Stories displayed on Zynga.com. If Zynga does not maintain its level of engagement with our users or if we are unable to successfully maintain our relationship with Zynga, our financial results could be harmed.
Facebook emphasised this because it is required by law to do so. That was one little month ago.
Meanwhile, the PR narrative from analysts and from so-called financial “reporters” has often dismissed the new threats to Facebook’s mobile revenues strategy–again it was Facebook itself that said “sponsored stories” was key to its strategy and now “sponsored stories” are in trouble due to a California lawsuit. Now that this strategy is in peril, there’s been hype about all the money Facebook will make from gifts, even though a similar strategy failed a couple of years ago. Even worse, its “sponsored stories” and “suggested posts” that are supposed to deliver the gift message in News Feeds are in trouble with regulators. More than that, Eyeo, developer of AdBlock Plus, just announced new software that will block ads on Android phones, the phone Facebook is urging its employees to use. Eyeo’s app will block Facebook’s ads.
Remember, just a month ago, Facebook warned us about the threat to user engagement if its relationship to Zynga should change.
Decelerating and Possibly Declining U.S. User “Growth”
In my November 26, 2012 report, I mentioned that overall user growth is decelerating. The deceleration problem is most pronounced in the U.S. and Canada. From September 30, 2011-12, the number of Daily Active Users (DAUs) grew from 124 million to 132 million–by only 8 million or 6%. Monthly Active User (MAUs) grew from 176 to 189 million–by only 13 million or 7.3%. Should you rely on those numbers? Given Facebook’s own estimation of its percentage of fakes, the number of users may have actually declined.
You’ll also recall that relative to the December 31, 2011 Facebook reported a 64-97% increase in fake users (69-104% increase in fakes if Facebook netted), or an increase of around 168-287% in fake users on an annualized basis (185-319% increase in fake users on an annualized basis if Facebook netted). It reported worldwide 8.7% fakes which translated to 83 million fakes (91 million fakes if Facebook had already netted out the fakes before reporting its numbers).
By having poor controls and leaving the door wide open for fraud, Facebook can claim that — in its opinion — users in the United States are increasing, but that’s not really clear at all. Facebook’s controls and the shakiness of its numbers have other plausible interpretations not found in its SEC filing. It’s also likely that users are declining. Facebook doesn’t really know.
Disclosure: I’ve bought and monetized puts on Facebook since they became exchange-traded shortly after the IPO. (“Investors Bet on Facebook Fall,” Kaitlyn Kiernan and Jonathan Cheng, Wall Street Journal, May 19, 2012.) I’m currently long other puts on Facebook.
See also: “Facebook: Soaring Fraud and Decelerating User Growth” (pdf) – TSF – November 26, 2012
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