Since its underwhelming release of second quarter earnings, Facebook’s shares have fallen from about $27-$29 per share to about $20 per share. The market is looking for the growth story to justify pricing at even current levels. That story is a mystery, the answer to which may or may not be forthcoming from Facebook’s management.
However, there is another mystery in the recent announcement. We look first at the second quarter earnings release (July 26, 2012), which was Facebook’s first public announcement of earnings. Then, we look further at Facebook’s first Form 10-Q, which was filed July 31, 2012 (before I finished this post).
The Second Quarter Press Release
Just how many shares does Facebook have outstanding? This is a fairly simple question, or so it would seem. However, the estimates seem to be all over the map for something that should be fairly straightforward.
Now Facebook does have a complex capital structure. In the last post on Facebook, we learned that Facebook’s Restricted Stock Units (RSUs) caused a charge to second quarter earnings of more than $1 billion. Even so, you’d think that the financial community would get things close.
Why does it matter? Well, the market value of equity (MVE) is determined by a simple equation:
MVE = Shares Outstanding (all of them) x Price per Share
At the time of the IPO, the market value of Facebook’s equity was widely said to be $104 billion. At an opening price of $38 per share, the implication is that there were 2.74 billion shares outstanding. Everyone was focused on the $104 billion and the $38 per share figures, and the shares outstanding somehow got lost in the shuffle.
What about today? Take a look at the following:
- Yahoo Finance – 1.879 billion shares outstanding (implied by the current market price divided by indicated market capitalization)
- GoogleFinance – 2.14 billion (stated) shares outstanding
- BusinessWeek.com – 2.4 billion shares outstanding (article July 28 – can’t find link right now)
- BusinessInsider.com – 2.74 billion shares outstanding (states confirmed by Facebook management)
Now what do we learn in Facebook’s second quarter earnings release?
- “Diluted” Shares – 1.879 billion outstanding. This figure was used in the calculation of Diluted EPS of a net loss of -$0.08 per share on a GAAP basis.
- Apparently Fully Diluted Shares – 2.458 billion outstanding. This figure is the result of dividing non-GAAP earnings of $0.295 billion by the indicated non-GAAP EPS of $0.12 per share. There is lots of room for rounding here, so this is just an estimate. The point is that Facebook didn’t state the number of apparently fully diluted shares in the press release. If the number of shares is 2.74 billion, then non-GAAP EPS would have been $0.1077 per share (rounded to $0.11 per share).
It is strange to me that Facebook did not provide an accurate total of fully diluted shares outstanding in the second quarter press release. It is also strange that the calculations of GAAP earnings and non-GAAP earnings were made using different numbers of shares outstanding. As a valuation analyst, I like to know how many fully diluted shares are outstanding in every valuation engagement. In fact, it is critical to have this information, because incorrect conclusions will likely be drawn to the extent that there is a disparity between shares outstanding on some basis and fully diluted shares outstanding.
What’s the Big Deal?
Based on these different estimates of shares outstanding, the market value of Facebook’s equity, or market capitalization, lies somewhere between $38 billion and about $50 billion (based on closing price on Thursday, August 2nd, of $20.04 per share.
In the meantime, Wall Street analysts are using different estimates for shares outstanding. Does that matter? Well, if an analyst’s earnings model indicated a market capitalization of equity of, say $60 billion, the estimate of value per share would range from $22 per share to $32 per share. Now wouldn’t it be embarrassing to make a stock recommendation based on the wrong number of shares outstanding? With the shares closing on Thursday (August 2) at $20.04 per share, an analyst might recommend the stock if he or she thought it had $32 per share potential.
Could something like this happen? I can’t tell you that it has, but I can tell you that the simplest mistakes, yes, the most obvious ones, are the most difficult to identify in many valuation situations.
If a lucky Facebook shareholder holds 100 million Facebook shares, that represents 0.0532% of the equity if there are 1.879 billion shares outstanding. However, if the actual number of shares outstanding is 2.74 billion, the same 1oo million shares represents only 0.0365% of the market value of Facebook’s equity. That’s a fairly big difference and represents a lot of dilution that shareholders should be interested in knowing about.
Now the economic reality will be the same at the end of the day, but the press and lots of others are confused by the mystery of Facebook’s actual number of shares outstanding.
Facebook’s Chance to Clarify
Facebook issued its first Form 10-Q on July 31, 2012. I held publication of this post until it came out to see if it clarified the mystery. It did not. Looking at the Form 10-Q we can see the following.
The “condensed consolidated balance sheet” of Facebook as of June 30, 2012 (at page 4) indicates that there are 641 million Class A shares issued and outstanding and 1.501 billion Class B shares issued and outstanding. The sum of Class A and Class B shares is 2.142 billion shares issued and outstanding.
In the discussion of “(Loss) Earnings Per Share” (page 10) we find the following:
For the calculation of diluted EPS, net income attributable to common shareholders for basic EPS is adjusted by the effect of dilutive securities, including awards under our equity compensation plans. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion from Class B common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. [This number is not provided]
The next paragraph continues a discussion of Restricted Stock Units and concludes:
No dilutive securities have been included in the EPS calculation for the three months ending June 30, 2012 due to our reporting a net loss for the quarter.
This may explain the mystery of why the GAAP and non-GAAP EPS calculations mentioned in the second quarter press release used different numbers of shares.
In the table calculating EPS on a GAAP basis at page 11 of the Form 10-Q, the number of shares used is 1.879 billion. However, that is a different number than the 2.142 billion shares indicated in Facebook’s balance sheet.
In the discussion of RSUs and share-based compensation at page 9 of the Form 10-Q we find:
We estimate that an aggregate of approximately 273 million shares underlying Pre-2011 RSUs will vest and settle between October 15, 2012 and November 14, 2012. These shares have not been included in our shares outstanding in our condensed consolidated balance sheet as of June 30, 2012.
If we add the 273 million unvested shares to the 2.142 billion shares in the condensed consolidated balance sheet, we get a total 2.415 billion shares outstanding. That is close to the number I estimated above (2.458 billion) based on the non-GAAP results calculated in the second quarter press release.
However, to get to the total of 2.74 billion shares outstanding that was apparently confirmed by Facebook’s management (BusinessInsider.com), there must be an additional 325 million shares floating around somewhere. I did not find mention of those shares, at least directly, in Facebook’s Form 10-Q.
Another Mystery in the Form 10-Q?
In Facebook’s first Form 10-Q, there is considerable information about Facebook’s pre-2011 and post-2011 Restricted Stock Units, or RSUs. In a coming post, we’ll take a look at the RSUs and share-based compensation that Facebook shareholders can anticipate over the coming months and years.