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Facebook Inc. founder Peter Thiel cashes out with $1 billion. Stakeholders have to ask, is this someone you really want on the board?By Greg Ruel, Senior Research Associate
On August 20, 2012, an SEC Form 4 form was released for Facebook founding investor and board member Peter Thiel, showing 20 million shares sold for a profit of nearly $400 million. Since May 22, 2012, total company stock sales for the Facebook director have eclipsed $1 billion.
Raising eyebrows, the venture capitalist dumped 80 per cent of his remaining shares, essentially cashing out shortly after the required trading lock-down for investors was lifted. At GMI Ratings, we’ve rated the company a solid “D” since its IPO. This divesture news has Facebook on watch as a company likely to join the five per cent of companies we rate “F”. To those who have been paying attention since the beginning, the company’s poor governance has been an unmistakable warning sign for investors to take heed, and a clear opportunity to avoid the resulting massive destruction in share price.
If a founder and board member is concerned enough to dump the vast majority of his shares, count us as equally concerned. More, the graphic below displays insider sales since selling restrictions were lifted. Not only have early investors been selling shares since the spring but Mark Zuckerberg himself sold more than $1 billion in shares in May when the stock was worth $37.58.
Mr. Thiel had a plan in place to sell these shares at the time of Facebook’s IPO so the sell-off isn’t likely a direct response to Facebook’s declining share price. It does however speak to the confidence he held in Facebook’s stock price once the company went public. It’s hard to blame an investor for ensuring a profit but it’s more than reasonable to question his inclusion on the board, especially once he essentially liquidates his shares. While his Facebook holdings are now a fraction of what he held before the IPO, he still represents the interests of long-term shareholders and this is troublesome.
There’s more to worry investors beyond insider sales and plummeting share prices. Last month, Facebook posted a fifth consecutive quarter of declining revenue growth. Furthermore, top executives have resigned in droves since the company went public. At the beginning of August, two more executives left the company, citing a desire to take part in more entrepreneurial activities. The Wall Street Journal article points out the conventional wisdom that top talent will often exit a company post-IPO when holdings may be liquidated and they’re free to pursue other endeavours.
Also of significant concern is the make-up of Facebook’s board. We’ve already discussed Mr. Thiel, who is “outside” as defined under Section 162(m) of Internal Revenue Code, but who just dumped $1 billion in shares on the open market. The chairman of the compensation committee, Accel’s James Breyer, is also deemed outside, despite selling about $2.1 billion worth of Facebook stock at the IPO and retaining another 43 million shares of Class A and B stock. Additional “outside” directors include lead director Donald Graham, CEO of The Washington Post, who purchased $4.2 million in advertising from Facebook in 2011, Reed Hastings, CEO of struggling Netflix Inc., and Marc L. Andreessen, the founder of Netscape.
Mr. Andreessen was a founder of Netscape Communication Corporation, a company which has recently drawn comparisons to Facebook for its massive early growth and near complete market share. However, like Facebook, Netscape had difficulty effectively monetizing its massive audience, and the company was eventually acquired by AOL. Facebook relies not only on frequent visits to drive advertising revenue, but also on lengthy stays by its users. However, many game developers are fleeing the popular social network for mobile aps and other platforms due to the increased cost of doing business with Facebook. Game developers, much like advertisers, are still weighing whether the cost of doing business with Facebook is even worth it. The games are crucial to getting Facebook users to spend more time on the site and increasing advertising revenue.
When the board was criticised for a lack of diversity, its rather defiant response was to nominate Sheryl Sandberg to serve as director. Ms. Sandberg is the company’s COO, adding another insider to the board while adding no new expertise to the director slate. All told, Facebook’s board now consists of two inside directors, two large investors, and four more directors who either have substantial related party transactions with the company or who were nominated to the board by Mr. Zuckerberg himself. It’s hard to point to a single director who has the long-term interests of the company’s independent shareholders as their first priority.
Facebook’s dual-class ownership structure is at least as concerning as its board configuration. Mr. Zuckerberg controls about 61 per cent of voting shares himself, with insiders and 5 per cent holders at nearly 80 per cent of vote control. Facebook’s ownership structure gives Mr. Zuckerberg 10 votes per share on his Class B holdings while common stock holders have one vote per share. In effect, though the company is now public, Mr. Zuckerberg is ostensibly free to ignore the opinions of common stock shareholders and exert complete control over the company. However, given the management friendly structure of the board, it’s difficult to envision he’ll receive much internal opposition from a board tasked with management oversight.
While we’ll have to wait for Facebook’s first proxy to get more compensation details, what we know so far is concerning. Incentive pay performance targets are unclear and appear to be mostly discretionary and at the will of the Compensation Committee. CEO and other key executive perks are in particular exceptionally high. For example, his 2011 total summary compensation included a discretionary bonus as well as “all other compensation” of $783,529, including personal aircraft use and estate and financial planning perks. Total summary compensation for named executive officers in 2011 included $31 million for recent board appointee and COO Ms. Sandberg, $25 million for Vice President of Engineering Mike Schroepfer, and about $19 million for Chief Financial Officer David A. Ebersman.
Previously, Mr. Zuckerberg received a mega-mega-grant of 120 million stock options in 2005 with an absurdly low exercise price of only $.06. At the company’s IPO, Mr. Zuckerberg exercised 60 million of these options for a profit of $2,276,400,000. To put this number into perspective, 2,021 Russell 3000 companies have market caps smaller than Mr. Zuckerberg’s realised profits.
Furthermore, Facebook has been embroiled in a sea of litigation since establishing themselves as a private company eight years ago, an issue that’s only been exacerbated by and since its disastrous IPO. Most recently on August 17, a U.S. judge rejected Facebook’s proposed settlement in a lawsuit alleging members right’s violations over advertising feature ‘Sponsored Stories.’
In June, Mr. Zuckerberg was sued by his own investors after selling more than $1 billion in company shares just as prices began to fall, sparking insider trading concerns. The lawsuit contends that Mr. Zuckerberg and Facebook knew that advertising revenue could not support the $38 stock valuation, yet selectively told only the company’s largest investors. Most troubling is the mountain of class-action litigation that surrounds the company’s IPO, with numerous lawsuits claiming omission of material information, such as reductions in revenue growth, from the registration and prospectus.
Similarly, a May 28 class-action lawsuit alleges the company informed analysts at the lead underwriters to lower second quarter financial estimates, though the news was kept quiet from the general public. As the news trickled out over May 21 and 22 of this year, Facebook stock lost 18% of its value, causing investors approximately $2.5 billion in losses. Though it’s been trading less than a half year, litigation against Facebook has been immense, and the potential toll on the company and investors is immeasurable.
While Peter Thiel’s $1 billion sell-off was most newsworthy, he wasn’t the only Facebook founder to dump a large batch of shares back on the market this month. Another Facebook co-founder, Dustin Moskovitz, made two separate sales on August 21st and August 24th of 450,000 shares each and was willing to sell for under $20 despite the panicked message such a move sends to the market. With enormous public pressure on the company at the moment, and a halving of the company’s stock price since the IPO, these founders are still willing to sell hundreds of thousands of shares. Facebook’s lock-up period was shorter than that of any of the 40 biggest U.S. technology IPOs since the end of 2010 and insiders have been all too eager to unload these holdings.
Despite an enormous amount of traffic, Facebook has yet to figure out a proper way to monetise clientele. More than that, mounting litigation, a management friendly board, insider cliff sales, compensation arrangements, and a one man fits all ownership structure have Facebook’s ESG rating and stock price simultaneously heading south.
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