Facebook IPO: A bet on 'King' Zuck

When Facebook executives and its bankers hit the road Monday to pitch the company's public offering to money managers, two questions will surely face prospective investors: Should we worry about the slowdown in the business? And what's up with Zuck calling the shots on, well, everything?

The answer to the first question is yes. Facebook does state in its IPO filing that "rates of user and revenue growth will decline over time." And while the company still has unprecedented reach -- an astounding 526 million active daily users -- that's a troubling harbinger given how Facebook has boosted revenue over the years by adding more users to its service.

But what Facebook will do to make more money off that already giant audience leads to the second question, which is a lot harder to answer: Can Mark Zuckerberg can keep coming up with the right answers?

That's because Zuckerberg exerts unusual control over Facebook because of his stock ownership. After the Facebook IPO, Zuckerberg will own 18.4 percent of the stock and control more than 57.3 percent of the voting power, a degree of influence that Facebook alludes to in the risk section of the S-1 document:

As a result, Mr. Zuckerberg has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets.

The dual-class tactic has long rankled shareholder advocates because it's used as a power grab, which is counter to the notion of a public company. Larry Page admitted as much in Google's S-1 from April 2004 when he wrote about the control he and co-founder Sergey Brin were giving themselves: "By investing in Google, you are placing an unusual long-term bet on the team, especially Sergey and me."

While Google started what's become a popular structure among tech companies going public -- LinkedIn, Zynga, and Groupon all took this route -- the issue goes farther back. In 1956, Ford Motor successfully lobbied the New York Stock Exchange so that it could go public with a dual class of stock despite the NYSE's one-share, one-vote rule at the time, said Charles Elson, the director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. As a result, Henry Ford and his family maintained control after what was then the single largest IPO in Wall Street history.

Media companies, too, have long used dual-class stock structures, from The New York Times to CNET's parent, CBS, at which Sumner Redstone has almost 80 percent voting control. For a public tech company, giving so much power to single individual is unprecedented.

This isn't generally a problem, until problems arise. Look at the stronghold Rupert Murdoch -- with nearly 40 percent control over News Corp. -- maintains over his embattled enterprise. "Investors have no opportunity to take action," said Elson.

Big mutual managers surely will wonder why they ought to put millions of dollars into a company that, with a potential $96 billion valuation, looks crazy by standard Wall Street metrics, such as price-to-earnings ratios. Zuckerberg has so much control over the company -- he designed it that way -- that a bet on Facebook is largely a bet on the talents of the almost-28-year-old tech wunderkind.

"You're betting on a king, on an old-style king," said Elson. "And if the king turns out to be not such a good ruler, you're stuck."

As a cautionary tale for potential Facebook investors, Elson points to Yahoo, which has seen plenty of CEO turnover owing to pressure from shareholders angry at the mess the business is in. Yahoo's current CEO, Scott Thompson, is now under attack by hedge fund Third Point. And last September the board ousted its last CEO, Carol Bartz, in a shakeup that couldn't happen at Facebook no matter how badly Zuckerberg stumbles.

"A board has two jobs," a person who's served on the boards of several public Silicon Valley companies told me, "acting as a sounding board, and hiring and firing the CEO. If the CEO wants to go ahead with something the board doesn't like, the only power they have is to fire him. And in Facebook's case, they can't even fire him."

Zuckerberg has already shown his desire to go it alone when it comes to big decisions. When he bought Instagram for $1 billion in cash and stock, he reportedly didn't even tell his board until the deal was all but done. Maybe board members questioned the price tag, as so many outsiders did after the deal was announced, but maybe they didn't. It probably wouldn't have mattered.

Of course, it'll be in Zuckerberg's interest for the stock to do well. For one, it'll keep his employees from jumping ship. It'll also provide him with a powerful currency with which to do more Instagram-like deals, and perhaps ones far larger.

And a bunch of outcry from finance profs is unlikely to dampen demand for this offer. This is Facebook, after all. Everyone knows it. Everyone wants a piece. And, despite the slowdown in the first quarter, this is still a profitable company on track to generate more than $4 billion in revenue this year. And though the king is just 27, so far he hasn't messed up.

It's also easy to argue Facebook's enormous potential, and that's what the bankers and Facebook executives will naturally stress during the upcoming road show, which is set to culminate with the IPO on May 18. Facebook already has frustrated advertisers eager to give it more money, and there's plenty of speculation that Facebook will become a place for e-commerce transactions, as its acquisition in April of a startup called TagTile suggests. And there's much more.

With such promise, fund managers won't want to be left out, even though money managers often shy away from IPOs with dual-class stocks. Retail investors also will likely jump in as soon as the shares start trading, even if they can't yet separate the price from the hype and all the pundits warn them to sit tight.

"This is one of those times when people act contrary to their own interest," Elson said. "The hype overwhelms good judgement."

Perhaps. But that good judgement also would have kept people out of Google, which since going public at $85 a share in August 2004 has climbed 617 percent. And Facebook seems a lot more Google than it does Groupon.