News Column

Facebook Stock at Mercy of Workers

Oct. 26, 2012

By Matt Krantz


Just when it looked as if Facebook shares might finally have found their footing, an event looms that could put the stock back flat on its face.

On Monday, current and former employees of the No. 1 social-networking company will be able to sell their shares for the first time. It's only the second time since Facebook's May initial public offering that lock-ups, which bar certain investors from selling their shares, have been lifted.

But unlike the previous lock-up expiration in August, which let early investors and venture capitalists sell, this is the first that lets employees cash in. And this has the potential to flood the market with shares just as buyers had been starting to show interest in the stock again.

And, most important, it will be the first time Wall Street gets to see how much Facebook employees "like" their company's stock.

Overnight, employees could uncork a surge of supply of Facebook shares on the market -- more than 230 million shares. That's roughly 11% of the company's 2.1 billion shares outstanding.

But wait -- there's more. This lock-up expiration comes just weeks before an even bigger potential onslaught. The unlock-up, if you will, that Wall Street is really bracing for is on Nov. 14, when 777 million shares are eligible for sale.

So in a roughly two-week period, new shares equal to almost half of Facebook's current shares outstanding become available for sale.

This happens at a time when beleaguered Facebook investors, to put it lightly, could really use a break. In less than six months as a public company, Facebook's storyline has been one misstep after another.

Bad news, then good news

Its much-ballyhooed May IPO turned out to be a disaster. Its plan for making money in the booming mobile market seemed nonexistent. Some of its biggest early investors dumped their shares. And its first earnings report as a public company, the second-quarter results, was a big disappointment. Pessimism was so pervasive that in early September the stock fell below $18.

This week, Facebook finally handed investors some good news when its third-quarter results beat expectations and showed it is making headway in the mobile market, boosting the stock nearly 20% in a single day.

That was small relief considering the drubbing Facebook has taken. The shares are still down more than 40% from the $38 IPO, so the additional supply that could flood the market is just about the worst thing for Facebook stock. "You have close to 1 billion shares coming through Nov. 15," says Malcolm Fobes, portfolio manager at the Berkshire Focus fund, which had a small position in Facebook as of the end of June. "I don't know if you want to be in ahead of that."

Are employees confident?

Lock-up expiration periods are pretty routine with IPOs. They're designed to protect initial investors to a limited degree, providing some assurance that employees and others won't pile on and sell immediately after a company goes public.

But the Facebook lock-up expirations are grabbing more attention than most because the IPO created such furor and then controversy. All the hype over social networking was concentrated in just a few stocks, with Facebook being the granddaddy of them all.

Wall Street is keenly watching because this will be the first indication of how loyal, satisfied and optimistic workers are with Facebook and its prospects. Rather than seeing their shares soar in the realization of a Silicon Valley dream, workers instead have watched as their company's stock has taken a beating. Until now, they had to sit on the sidelines. Starting Monday, if they think the company's future is still promising, they can hold onto shares. If not, they can sell.

Many Facebook employees were given restricted stock units that would be converted into shares after the company went public. Depending on how long the employee has been at the company, the cost basis on the shares will be next to nothing. That means even though the stock is down 40% from the IPO price, employees who sell will be looking at essentially pure profit. Some might feel it's prudent to sell at least some shares, cashing in to pay for big expenses.

"Employees have been waiting for their money for so long, postponing major purchases, I think a good portion will sell and be done with it," says Francis Gaskins of IPO Desktop Premium.

Still, how the stock performs in the wake of Monday's expiration will provide a barometer of how Facebook employees feel about the stock, says Jason Malak, managing director at CBIZ Valuation. "If employees sell the stock, that sends a bad message to others that the price could go down," he says. "They might know something you don't know."

Right now, employees aren't saying what they plan to do once they are free to sell. Due to the sensitivity of the topic, most of the more than two dozen current and former Facebook employees that USA TODAY attempted to contact either didn't return calls or e-mails, flatly declined to comment or wouldn't talk on the record. Facebook, too, declined to provide any comment or tell USA TODAY what services it is providing its employees to manage this financial decision.

Even those who are willing to talk aren't saying much about their plans. Paul Ollinger says he was one of the original 250 employee at Facebook after joining the company in 2007 as an executive overseeing sales on the West Coast. He still owns shares, but declines to say how many or what he plans to do with them when he's able to sell. "I am very bullish on the company, its people and the long-term value of the stock," he said in an e-mailed response.

The first lock-up expiration, on Aug. 16, proved to be a major stumbling block for Facebook. Its stock set what at the time was a new low, $19.87 a share, in heavy trading.

Shortly after the expiration, it was disclosed that large early investors such as venture capitalist Peter Thiel were among those who took the opportunity to unload massive amounts of stock.

And now the fear is that the first lock-up expiration was just a hint of what might happen this time around, considering the much greater magnitude of new supply involved.

Since Facebook's stock is down so much from the IPO price, that might discourage employees from selling, says Tim Keating of Keating Capital. Employees might sell 10% of their holdings to "get a bonus," but many will likely hold on to see if the shares recover, he says.

Profiting in a mobile world

This is just the latest test of how willing investors are to be patient and wait for social networking to pan out. Despite high hopes, social media has been a bust for most investors. Shares of many of the promising social-networking companies have crashed as the hope of profit remains elusive.

The most dramatic example is Zynga, the online game company that gets much of its revenue by providing games over the Facebook website.

Shares of Zynga came public in December 2011 at $10 a share. Since then, the company has warned it's not doing as well as previously thought, and the shares have plunged to $2.39.

Facebook is at a similar crossroads, especially with its ability to find ways to make money as users increasingly access the site using smartphones, says Terry Connelly, dean emeritus of San Francisco Golden Gate University. The company's ability to convincingly create a business model that is bolstered by mobile, rather than threatened by it, is more important than any short-term supply issues created by the lock-up expiration, he says.

But while Facebook might have time to find ways to profit in a mobile world, the lock-up expirations are real and a big hurdle to overcome in the eyes of investors. Facebook's shares are still relatively pricey, trading at 78 times its earnings over the past 12 months. Compare that with the P-Es of Microsoft and Google of 15.1 and 21.2, respectively.

"Investors think Facebook has more growth ahead of it, but does it?" Keating says.

"Once investors start selling the stock, it's going to make a bad situation even worse," Malak says.

Source: Copyright USA TODAY 2012

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