Saturday, January 22, 2011

Should You Buy Facebook Through a Special Purpose Vehicle?

Facebook is skirting SEC Rules by selling stock through intermediaries on the "secondary" market.  The company that touts openness and transparency doesn't want you to see its internal finances.

Facebook recently took a $500M investment from Goldman Sachs (those nice folks) and you can now buy a chunk of facebook through a "Special Purpose Vehicle".  The point is probably moot, as Goldman is only allowing its wealthiest investors to purchase Facebook "shares" through this investment mechanism.  But it is an interesting strategy - and neat way around the SEC.

How does this work?  Well under most corporate rules, you have to limit the number of shareholders if you are a sub-S or LLC type company.  Facebook has a limited number of shareholders, mostly insiders or early investors.   And you can buy and sell these "private shares" on the secondary market, but few are available.  One way around this is to make each shareholder itself an LLC or Sub-S corp or other type of entity.  Is this legal?  Apparently so.  But it does give on pause.  If more and more companies do this, in response to SEC regulations, it could create a whole shadow stock market, unbeholden to regulations and scrutiny.  And that would not end well, let me tell you.

The stock market crashed two years ago.  And the cause of this wasn't too much transparency.  Enron didn't collapse because it's books were properly balanced and scrutinized.  No, quite the opposite.  When companies make their financials opaque, it never ends well for the investor.

But apparently, this idea of investing through the back door is nothing new.   People did this years ago with Berkshire Hathaway, is its "A" shares sold for over $100,000 apiece, more than the average schmuck like you and me can invest.  So people set up S-corps to hold the shares and then sold off shares in the S-corps to others, neatly skirting the SEC and other securities and corporate regulations.

In response to this, Berkshire-Hathaway set up a B-type share, so that these middle-men would no longer profit from selling, in essence, fractional shares of the company stock.

But Berkshire-Hathaway, being a listed stock, has to disclose company financials.  Facebook, not being listed, does not.

So what are you buying when you buy Facebook?  A pig in a poke.  And as I noted in an earlier posting, it is not clear whether Facebook has made a profit or ever will.  Some sources claim it has yet to make a profit, while others say it made a slight profit in 2009.

One thing is clear, if it was profitable, there is no reason it could not go public with an IPO and sell shares.

Why would you take on investments in this back-door manner?  Why would you keep information secret from investors?  Well, I can tell you this, not for reasons that would be advantageous to investors.

So why are people buying shares in facebook?  Because people are idiots.  It is an example of Faith-Based Investing - investing based on the idea that something is worth something and will be worth more - based on little more than faith and hoopla.  They see a popular website that is getting a lot of attention, and assume it is worth something.  But in reality, if it is not profitable, what is it worth?  And the main question, if you are investing in something like this - what is the long-term future and growth for this site?

As I noted in an earlier posting, it is all too easy to get snookered in by Internet websites.  They seem so permanent and important, but end up being ephemeral.   The one thing we have learned about the Internet in the 15 years or so that it has become popular with mainstream America, is that what is the "hot site" one day is the "dog site" the next.

And it can happen to any Internet organization, even ones that seem permanent or impenetrable.

I spent a lot of time on Facebook initially, checking it about once a day.  But over time, my interest has flagged.  I never got sucked into stupid games like "Farmville" and also it became a bit of a chore to check out everyone's "feed".  And once you've discovered what happened to all your friends in High School, the interest flames out quickly.  At this point, I visit Facebook maybe every other day, or every third day, and my time on the site gets shorter and shorter.

I love my friends, but you know, sometimes I don't really need to know what they ate for dinner last night, or what their favorite TeeVee show it.  There is such a thing as too much of a good thing!

So Facebook could just be a fad - like MySpace was, and investing in fads or trendy stocks is tricky.  Why?  Because you are not really investing, but gambling - on long shots, and hoping that your "pick" will be the market winner down the road.  And while Facebook could be a market winner, you might have thought the same about MySpace only a few years ago.

The problem with Internet web sites (and that is ALL THEY ARE, websites, nothing more) is that the owners of the sites can screw the pooch and kill the business in short order.  Change the format, make it harder to use, make it too crassly commercial, put in too much SPAM, harvest too much data, allow viruses or other scams to proliferate, or just stop providing something new and interesting.  Facebook seems to do all of these, on a regular basis.

And it could happen to any Internet site.  PayPal nearly went under, until rescued by eBay, as they created an aura of wild-west lawlessness and destroyed the "trust" factor needed to persuade people to link their bank accounts and credit cards to the site (many still refuse to do so, and you can't blame them, can you?).  eBay constantly has to police itself, as scammers and con-men have used the site to steal millions of dollars from users.  If they get the reputation as a haven for scammers, who will buy there?  Even sites like Craigslist, which has a "hands off" approach to their content, is constantly revising itself and warning users, lest it lose what little reputation for trust it has garnered (and it has little!).

And speaking of which, have you ever looked at the ads on Facebook?  Most are come-ons for the most odious sorts of bad bargains, if not outright rip-offs.  How long can you screw your customer base, before they just walk away completely?  If you see something advertised on Facebook, 9 times out of 10 it is an utter rip-off.

Facebook, to me, doesn't seem like a sound, long-term investment.  But of course, I could be wrong about all of this - and in fact, I probably will be, at least initially.  You see, most of the investment in these Internet companies is based on the same premise as that which is driving up Gold, or blew up the housing market or blew up the last "dot com" bubble.  It is what I call "the greater fool theory".

A friend of mine had a small "dot com" company back in the 1990's.  What it did, I could not tell you, as it was one of those deals where he explained the "sea change" and "new paradigm" for 15 minutes and you still had no clue what he was doing.   Something about counting clicks or click-through or getting paid for clicks.  He had a small revenue stream, but was not making money.  He hoped to sell the company for a ton of dough to investors.  There was no plan to operate the company and make money from it - that was impossible.  Rather, he hoped that "some greater fool" would pay even more for it, and he could "cash out" and win.

Problem with that theory, is that eventually, you run out of fools.  You run out of people who will buy overpriced mini-mansions on the premise that someone down the road will pay more.  You run out of people willing to buy gold on the premise that down the road, someone will pay more.  And you run out of "venture capitalists" willing to pay money for a money-losing "dot com" company, on the premise that someone down the road will pay more.

And Facebook, it would appear, is another money-losing "dot com" company in that regard - or if it is making money, not making much.  (Think about it for a second, if Facebook was such a cash cow, why would Zuckerstein et al. sell even one penny of it?  You never sell the goose that laid the golden egg.  You only sell geese that you can convince suckers will lay golden eggs!).

So yes, short-term, some people who gamble in the stock market might make money.  But as in any casino, others will lose and lose big.  As a long-term investment?  It ain't General Motors.  Heck, General Motors ain't General Motors - anymore!

And if you are willing to invest in a stock based on no more than the brand name, the media hype, and "trust me, I know what I'm doing" - and are explicitly not allowed to look at the books, well, all I can say is "Good Luck with that!".

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