The Future of the Public Company – Facebook is Buffett's Heir
Nick is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Currently, the professional Fools are debating whether to face it or book it. Both sides like to characterize Facebook as a country – either as the third largest in the world or as North Korea. The former is closer to the truth. Facebook is like India: A highly entertaining (even beloved) ecosystem that has a skyrocketing population, lots of promise, and the potential to destroy the world. However, its success is being piloted by weak leadership that in reality is being carried along by the fortunes of others rowing its boat as the tide rises.
Facebookies wagering on social media are right to point to games being a growth area for the company. With major entertainment players having yet to adapt and create for the social network’s members, it is not hard to imagine that this segment could eventually account for more than the 15% of the revenues it currently generates. (After all, if history is any guide, it's not the delicious cardboard pizza at Chuck E. Cheese that attracts the crowds, it's the Whac-A-Mole, play money, and family fist fights...) However, the question remains, Why hasn’t Facebook been able to attract more entertainment titans? Probably for the same reason General Motors pulled its $10 million in advertising – the Facebook sales team is reportedly not very convincing (bumbling even).
Still, popular anecdote aside, advertising is what brings in the bulk of Facebook’s revenue, and detractors are right to point out how irrelevant many of the ads they receive tend to be. Yet, imagine how many more billions the Facebook team would rake in if they actually did improve their advertising algorithms. (They certainly can’t get any worse, right?) Moreover, while the Facebook team itself is not getting any rave reviews, other companies (especially overseas) are figuring out how to use the platform to meet their own needs and showing some success.
Similarly, it seems the Wall Street Goldilocks knew better than Facebook itself how to price the initial public offering (not too hot, not too cold for the insiders that put up their shares). Despite all the commentary and the subjective nature of what “successful” has come to mean, the fact remains that the company did have the largest IPO in history and the shareholders got the amount they advertised for. The frenzy around the May 18 IPO said more about the declining state of public investing than it did about the future prospects of Facebook’s fortunes. Certainly the lemming party would have continued if not for the technical difficulties that curbed their enthusiasm.
However, misplaced public exuberance for a popular brand in the zeitgeist coupled with the increasing rarity of IPOs (mistakenly believed to be the closest thing to a Golden Ticket the average investor will ever know) is not the only cause for the unattractiveness of public capital markets. Regulations and other government attempts allegedly designed to impart more power to the people (or at least shareholders) have been largely sidestepped or lawyered around – the Facebook voting rights structure is a masterpiece in that regard. Moreover, with only a few weeks past and politicians and lawsuit-entrepreneurs gearing up for their moment in the spotlight, it may be a while before investors can sift through the blowback and discern if they should reach for their Ruby Slippers.
Building on the perspectives offered in their book, The Company: A Short History of a Revolutionary Idea, the editors at The Economist recently pointed out in their piece, “The Endangered Public Company: The Rise and Fall of a Great Invention, and Why It Matters,” that “Companies are like jets; the elite go private,” and illustrated how Facebook is emblematic of our times:
Mark Zuckerberg, Facebook’s young founder, resisted going public for as long as he could, not least because so many heads of listed companies advised him to. He is taking the plunge only because American law requires any firm with more than a certain number of shareholders to publish quarterly accounts just as if it were listed. Like Google before it, Facebook has structured itself more like a private firm than a public one: Mr Zuckerberg will keep most of the voting rights, for example.
The Economist goes on to show that since the 1980s not only has the number of public companies declined by over a third in the US (by almost half in the UK), but that IPOs in America have gone from over 300 a year to less than 100 today – and among small-caps IPOs have gone from 165 to 30. (Of course, the number of other publicly traded instruments, such as ETFs, which largely repackage existing stocks, have exploded.) For the public in general, the stunting of public companies under the current regulatory regimes exacerbates problems of slower growth, restricts opportunities to elites, and perverts true transparency.
Counterintuitively, the harbinger of this trend has been Berkshire Hathaway. The core proposition (aside from avoiding estate taxes) for the numerous subsidiaries of the conglomerate is that Berkshire's shocking corporate structure and awe of Warren Buffett allows access to public capital while being largely shielded from the demands of operating as a public company. Berkshire is also clearly the inspiration for Facebook’s much maligned corporate governance structure. Even if the social media giant dies a quick death, the “voteless shares” model will be the holy grail that will likely live a long life. (Just as its ancestor the golden share retains its popularity among governments like Russia.)
For those Fools that knelt at the clay feet of their patron saint of public companies and asked, “What Would Warren Do?” the conclusion was foregone. It was no surprise that Buffett avoided Facebook (and not because it was a "tech" stock). He has clearly stated he does not invest in businesses he does not understand. Unlike the transparent and straight-forward financial statements of major banks he owns (not), Grandpa Buffett has yet to understand how to wring more public subsidies from Uncle Sam for the social media sector – which has been his approach to “value” investing since the recession began.
Nevertheless, Facebook should be interesting for investors not because it shoulda, woulda, coulda been the next gold rush, but because it is a good starting point for those looking for the next Levi Strauss (and its mythical rise on the shoulders of the Forty-Niners). Companies that serve the needs of those passionate masses trying to figure out ways to get their dreams off (and out of) the ground are usually less well-known than celebrity stocks like Facebook (and its Calvin Klein hoodies). More important, speculators should consider that the recently de-naturalized Eduardo Saverin joins other economic refugees like commodities legend Jim Rogers in Singapore – many of whom have shown themselves not only lucky like a Zuckerberg, but also capable of making their own luck in numerous ventures without putting it all down on Black 18. It should also serve as a canary for elected officials that treat tax policy as an ATM. (Even the current Spider-Man, who portrayed Saverin in The Social Network, is using his British nationality to hedge against onerous US taxation – art imitates life imitates art…)
Ultimately, like airlines, social media seems more useful as an indicator of global trends than as a direct investment. Maybe Facebook’s a new fad. Maybe Facebook’s a new phone manufacturer. Maybe Facebook’s a new form of utility. Maybe Facebook’s a fun hobby that got out of hand. Maybe Facebook's leaders (let alone anyone else) have no idea. Maybe there are better investments than Facebook.
Nick Slepko has no position in any company mentioned here at the time of publication. The Motley Fool owns shares of Berkshire Hathaway and Facebook. Motley Fool newsletter services recommend Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.