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Facebook's Stock Price Is Too Low, Says Facebook

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Last week the Journal ran this sort of strange column from Ronald Barusch about IPO lockups asking "What is the point of the lockups to begin with and who gains from them?" and answering (1) without lockups "public offering prices would be lower to account for the risk of immediate sales by the insiders" and (2) "But who says that lower prices for selling executives and institutional investors — and for buyers in an IPO — would be a bad thing?" So that last question is actually pretty easy to answer: the selling executives and institutional investors say that lower prices would be a bad thing, because U'(W) > 0 etc. Thus, they sign lockups, limiting their own freedom to sell more shares in exchange for more money now. Or such is the theory, sold to them persuasively by bankers.

So what do you make of this?

Facebook Inc. Chief Executive Officer Mark Zuckerberg won’t sell his stock holdings in the company for at least a year, according to a regulatory filing.

Facebook’s shares have been marking record lows since the first lockup on share sales by insiders expired in August. Zuckerberg, who operates the world’s largest social-networking service, is facing investor concerns about how the website can generate more revenue from its growing user base.

Directors Marc Andreessen and Donald Graham also said they won’t be selling shares in Facebook, other than to settle tax obligations, the filing with the U.S. Securities and Exchange Commission said.

Shares in Facebook rose as much as 2.9 percent in after-hours trading, up from $17.73 at the close in New York.

Part of me, as a one-time capital markets banker, wants to yell at them: why not sign longer lockups then? But of course that's dumb; memories are fickle and path-dependent and it's not like Zuck's 180-day lockup was nonstandard. Also: Facebook got $38 and won't see that again for a while, so it's not like they really left money on the table by not burying a 15-month Zuckerberg lockup on page 155 of the prospectus. You might instead ask why Zuckerberg wants to constrain his freedom today, to prop up FB's stock price when he's not selling any, but of course he's not really constraining himself - the 8-K only says he "has informed us that he has no intention to conduct any sale transactions in our securities for at least 12 months." Intentions can change.

The other, more interesting part of the 8-K - and a potential explanation for "why prop up the stock now?" - is this:

We currently expect that two trading days following the announcement of our third quarter 2012 financial results, we will vest and settle outstanding Pre-2011 RSUs .... To settle these RSUs, assuming an approximate 45% tax withholding rate, we anticipate that we will net settle the awards by delivering an aggregate of approximately 124 million shares of common stock to holders of Pre-2011 RSUs and withholding an aggregate of approximately 101 million shares of common stock. The 101 million shares that are withheld by us as a result of the net settlement of Pre-2011 RSUs will no longer be considered for accounting purposes to be issued and outstanding, thereby reducing our shares outstanding used to calculate earnings per share. ...

Assuming the price of our common stock at the time of settlement was equal to $19.09, the closing price of our Class A common stock on August 30, 2012, we estimate that the aggregate tax obligation for the settlement of these RSUs would be approximately $1.9 billion. ... We intend to fund these tax withholding and remittance obligations by using our existing cash and borrowings from our credit facilities. We currently do not expect to conduct any offering of our equity securities near the initial RSU settlement date to fund this obligation, nor do we currently expect to conduct an offering in connection with the expiration of “market stand-off” or “lock-up” restrictions in the fourth quarter of 2012.

Those shares come on the market in late October, and I guess the Facebookers will be salivating over them a bit more if they're priced with a two handle. Henry Blodget refers to the above as a "Massive $2 Billion Share Buyback At Less Than Half Of The IPO Price," which, I mean, let's ignore what work "massive" is doing in front of "$2 billion" and focus on "share buyback": is this a share buyback? It depends on your baseline; in the normal world, companies pretty much always net share settle RSUs for withholding purposes and then pay the withholding in cash,* and rarely issue more shares explicitly to pay for it, making this less of a "share buyback" and more of a "issuing fewer shares than you'd otherwise issue, if you were issuing more shares, which you probably wouldn't be."

But here Blodget is exactly right: Facebook was going around saying it would issue more shares to pay this withholding, so those extra shares were in everyone's expectations. From the prospectus:

To fund the withholding and remittance obligations, we expect to sell equity securities near the initial settlement date in an amount that is substantially equivalent to the number of shares of common stock that we withhold in connection with these net settlements, such that the newly issued shares should not be dilutive. We have an exception in our “lock-up” agreement with our underwriters that would permit us to raise capital in an underwritten offering to fund these withholding and remittance obligations. However, in the event that we issue equity securities, we cannot assure you that we will be able to successfully match the proceeds to the amount of this tax liability. In addition, any such equity financing could result in a decline in our stock price. If we elect not to fully fund tax withholding and remittance obligations through the issuance of equity or we are unable to complete such an offering due to market conditions or otherwise, we may choose to borrow funds from our credit facilities, use a substantial portion of our existing cash, or rely upon a combination of these alternatives. In the event that we elect to satisfy tax withholding and remittance obligations in whole or in part by drawing on our credit facilities, our interest expense and principal repayment requirements could increase significantly, which could have an adverse effect on our financial results.

This incidentally is a great piece of prospectusese: if we elect not to dilute you and instead are forced into drawing on our very cheap credit facility, we will have to pay back that credit facility. "Shares in Facebook rose as much as 2.9 percent in after-hours trading, up from $17.73 at the close in New York," so I guess no one is too broken up about that now.

One thing to maybe think is: if this is SUPER GREAT NEWS, and you go and buy a lot of FB stock, and you push the price up to $45, what will Facebook and Zuck do? Well, Facebook will probably ... um ... sell stock to pay for the tax withholding on those RSUs, no? (That was its original plan mainly because the withholding obligation goes up as the stock price goes up, meaning at some point it'd be using all its cash to pay that withholding.** With the stock at $100 it would have no choice but to sell stock.) And Zuck will ... I mean, probably not sell stock, but he at least won't feel too constrained by today's "no intention to conduct any sale transactions in our securities for at least 12 months? Andreessen will be out of there like a shot off a shovel.***

I think all this 8-K says is "we try to buy low and sell high; we did a good job of top-ticking you at $38 in the IPO but we're not going to be complete chumps at $17.73 - get it back in the $30s and we'll talk." Which really shouldn't be news. But as Blodget points out, most companies do more like the opposite. So I guess that justifies a positive reaction to Facebook's announcement that they have some price discipline: it doesn't mean much, but it's better than the alternative.

Facebook CEO Won’t Sell Shares For At Least A Year [Bloomberg]
Facebook Announces Massive $2 Billion Share Buyback At Less Than Half Of The IPO Price* [BI]

* So I mean here in banking, but also here in tech, additional examples left as an exercise etc. but, no, companies that have accountants don't normally go around (1) evading withholding requirements on comp or (2) asking employees to stump up the money for them.

** Not, incidentally, at the point of $38 a share. You might read the original prospectus's "we will need to issue stock to pay that withholding" to imply "... if the stock hits $100 as it surely will." If it'd stayed at $38 would they have sold the shares?

*** I have no basis for saying this. But he's a VC and thus all U'(W) > 0, whereas Zuck has an empire to build.