Thursday, September 6, 2012

Facebook's Shares Outstanding

Facebook (FB) took action earlier this week that effectively reduced their shares outstanding by 101 million.

Prior to January 1, 2011, Facebook granted restricted stock units (Pre-2011 RSUs) to employees (including executive officers), and members of their board of directors. From the latest Facebook 8-K:

...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. 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.

In the 8-K filing, they added that the 101 million shares will be eligible to be granted as new awards (future dilution) under their 2012 Equity Incentive Plan. The company also said that assuming the price of their common stock at the time of settlement was equal to the August 30th closing price...

...we estimate that the aggregate tax obligation for the settlement of these RSUs would be approximately $1.9 billion.

The filing also says...

We intend to fund these tax withholding and remittance obligations by using our existing cash and borrowings from our credit facilities.

Once this action is complete, Facebook should have approximately 2.64 billion shares outstanding based upon the filing.*
(This will not necessarily be the same as what is reported as fully diluted shares outstanding though, over time, it should end up being a pretty decent estimate. See Treasury Stock Method.)

Some of the more popular finance sites show shares outstanding for Facebook to be much lower than this 2.64 billion number. The confusion is somewhat understandable. For now, these sites appear to be using a share count that's not fully diluted. I'm sure it will be sorted out as we get further from the IPO.

The fully diluted share count -- which accounts for stock options, RSUs, and shares issuable upon completion of the Instagram acquisition -- is the one to use in order to get market valuation and per share measures right. Facebook's relatively complicated capital structure (different classes of stock, stock options, and RSUs) is at least part of the reason for the mix-up.

In effect, Facebook is buying back stock even if the proceeds they'll be paying (to "buyback") just happens to be in the form of a tax. So it functions like a buyback even if the cash doesn't end up in the hands of selling shareholders. In other words, it's not like the reduction in shares outstanding is coming at no cost. As is true with any buyback, the most important thing is whether they're buying those shares back comfortably below per share intrinsic value.

Multiply the 2.64 billion shares outstanding by the current price of $ 19 per share gets you to the ~$ 50 billion market value. The company is making money but their earnings are not yet backed by quality free cash flow (FCF).

In fact, FCF in the 1st half of 2012 was negative. We'll see if that improves over time but it's worth keeping an eye on.

Use of the not fully diluted shares outstanding is making Facebook's market value appear lower than it actually is. The difference isn't inconsequential. Some sites now still show Facebook as having a ~$ 40 billion market value near current prices instead of the ~ $ 50 billion.

I won't be surprised if Facebook is going to be worth quite a lot someday. Maybe even much more than it's current valuation. That doesn't mean at today's valuation it will provide acceptable compensation for investors or a sufficient risk-adjusted return. There seems, at least to me, many other more attractive risk-adjusted alternatives with a narrower range of outcomes.

Judging how valuable something this dynamic is (and how valuable it is likely to become) and the appropriate price to pay TODAY isn't easy. Personally, I simply don't buy anything unless I can gauge the risk of permanent capital loss (both in terms of size and likelihood). I think it is fair to say the range of outcomes for a business like Facebook is relatively wide. Figuring out the appropriate margin of safety seems to me difficult at best.

In any case, plenty has to go right for the current valuation to make sense.

Even though Facebook's stock has fallen hard since the IPO, the company still has more than twice the market valuation that Google (GOOG) had when it went public. The question is whether Facebook's business will have anything like the kind the trajectory that Google's business has had.

I certainly have no idea.

Google earned nearly $ 1.5 billion the first full year after its IPO (not so unlike the current expectations for Facebook) and should earn nearly $ 11 billion or so this year. If Facebook has anything like that ahead of it then the current seemingly high valuation won't turn out to be so elevated after all.

Adam

Long position in Google

Related posts:
Is One Apple Really Worth Less Than Four Facebooks
Facebook Drops Ahead of IPO: 1st Quarter 2012 Results
Facebook Files for IPO: What the S-1 Reveals
Facebook's IPO: $ 100 Billion Valuation?
Facebook's 1st Half Revenue Doubles to $ 1.6 Billion
Is Facebook Worth $ 100 Billion?
Technology Stocks

* Prior to the action taken earlier this week, 2.74 billion was roughly the correct share count (confirmed by Facebook). At the time of the IPO, many seemed to be using something close to that number. 
(In fact, one can't get near the reported ~ $ 100 billion plus valuation multiplying the share price at the time of the IPO by the number of shares currently being reported on some finance websites.)
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