Facebook – The piper calls

Investors will now pay the price of allowing poor governance.

• The move to oust Mark Zuckerberg will almost certainly fail in the strongest signal yet that companies with uneven share voting structures should attract a discount to their valuation.
• An attempt is being made to remove Mark Zuckerberg as chairman that is almost certain to fail because unless Zuckerberg votes for the motion himself, it will fail.
• This is because of the dual voting structure where the A shoulders hold 82% of the economic interest in the company but only 32% of the voting power.
• The B shares which make up 18% of the economic interest in the company control 68% of the vote.
• Mark Zuckerberg owns over 75% of the B shares meaning that he alone controls at least 51% of all votes cast.
• Consequently, any motion that he does not like will fail as the majority of shares will be cast against the motion.
• The reality is that Mark Zuckerberg has complete control over Facebook, the election of its directors, the makeup of its board, its strategic direction and any major M&A that is entered into.
• I have said many times that while things are going well and the shares are going up, no one cares but when things begin to go wrong, they will go wrong for longer than if management can be removed by minority shareholders (see here, here, and here).
• This is exactly what is going on with Facebook and the current crisis that it now faces.
• When problems arise, founders tend to be more emotionally attached to losing strategies than professional managers.
• Because no one can force them out or to change, they tend to stick with these losers for far longer than they should.
• The result is that problems tend to be far worse and last much longer than they otherwise would if the shareholders had the power to enact change.
• Consequently, A shareholders are stuck with Zuckerberg until he himself decides to go and there is nothing that they can do about it.
• When I look at a company, I take this into account by applying up to a 30% discount to the fair value of the shares depending on the degree to which smaller shareholders are being disadvantaged.
• Companies like Google, Facebook and Baidu get the full 30% discount.
• If the company is still attractive after that discount, then I am happy to own it knowing that I am being properly compensated for being unfairly treated.
• With margins to fall another 500bp this year, weak AI and a general slowdown, Facebook is not close to being attractive even before I have applied the 30% discount.
• Holding the shares for the rest of this year is likely to result in the piper having to be paid in heavy coin.