Facebook Stock: New Strong Sell Signals

FILE - In this Oct. 10, 2011 file photo, a magnifying glass is posed over a monitor displaying a Facebook page in Munich. Reg
FILE - In this Oct. 10, 2011 file photo, a magnifying glass is posed over a monitor displaying a Facebook page in Munich. Regulators are examining whether Morgan Stanley, the investment bank that shepherded Facebook through its highly publicized stock offering last week, selectively informed clients of an analyst's negative report about the company before the stock started trading. The bank said on Tuesday May 22, 2012 said that its procedures complied with regulations. (AP Photo/dapd, Joerg Koch)

When insiders sell stock, that's usually a strong sell signal for everyone else. As I mentioned in a previous post, many of Facebook's early investors cashed out rather than hang onto their shares, and the stock price plummeted from the IPO price of $38 (at one point the share price had risen to $45) to close at $21.94 on Friday. In after-hours trading, Facebook (ticker symbol FB) traded down another 1.33 percent to $21.65. Trading was closed Monday and Tuesday due to Hurricane Sandy, but trading reopens today.

After trading hours on Friday, October 26, several senior Facebook officers made required filings of 4s forms to the SEC reporting that on October 25, they converted their newly unlocked restricted shares from Class B common shares, which get ten votes, to Class A common shares which only get one vote. Unlike the Class B shares, the Class A shares can be traded in the public market. In fact, the only reason to give up the ten times voting rich Class B shares for Class A shares is to ready yourself to sell the shares, since Facebook offers no economic value when the exchange is made. In other words, as soon as their shares were unlocked, Facebook's officers got them ready for sale in the open market.

Moreover, lockups expire for other Facebook employees, and before year-end a tsunami of Facebook shares are eligible to hit the market.

Few new buyers will likely step in at the current price given the previous wave of insider selling, several resignations of top Facebook officers, security holes, potential double counting of mobile users who also access Facebook from computers, potentially inflated user counts due to phony profiles and imposters, pressure on Facebook's margins and profitability, questions about its strategy, serious failures to protect users' privacy, advertiser complaints of bots clicking on ads and inflating their costs, Facebook's sudden changing of algorithms to the detriment of advertisers, multiple lawsuits, and price to earnings multiples that are extremely high versus other technology stocks and other stocks in the S&P

Facebook currently has 692 million shares of stock "float" in the public exchange-traded market, and around 70 million shares trade each day. High volume sales may cause huge downward pressure on the stock price as it did in the past. But first let's get back to the Facebook officers. Here are their names and the number of Class A shares they readied for sale and the value of the shares at the conversion price of $23.21. Note that both the closing price on Friday of $21.94 and the after-hours trading price of $21.65 are already below the officers' conversion price the day before. The bulk of the shares belong to Sheryl Sandberg, Facebook's COO:

Theodore Warren Ullyot, General Counsel and Secretary: 2.5 million shares ($58 million) or which 1.4 million are ready for sale.

David Ebersman, CFO: 4.2 million shares ($97 million), with 2.2 million ready for sale.

David Fischer, VP Mktg: 1.1 million shares ($26 million), with 568, 282 shares ready for sale.

Sheryl Sandberg, COO: 34 million shares ($790 million), with 15 million ready for sale.

Michael Todd Schroepfer, VP Engineering: 2.8+ million ($66 million), with 1.5 million shares ready for sale.

David Spillane, Chief Accounting Officer: 0.7 million shares ($16 million), with more than 415 thousand ready for sale.

The share numbers and dollar amounts are net after taxes. Facebook withheld around 46.6 percent of the stock awards as "B" shares and intends to use Facebook's own cash and borrowings to pay the taxes. Note that is an intention, not a legal requirement, and Facebook may change its mind and convert the withheld Class B shares to Class A shares and sell them if it deems that is the best economic outcome for the company. While it's good that the shares aren't yet available for sale, notice that Facebook itself has effectively purchased the remaining more than 21 million shares at the conversion price of $23.21 ($487 million). Facebook is also withholding stock and handling the tax bills of other employees whose shares will be unlocked.

Including the newly unlocked shares of officers mentioned above, here's Facebook's schedule of unlocked shares before year end:

Oct. 29, 2012 234 million shares
Nov 14, 2012 777 million shares*
Dec 14, 2012 156 million shares

* According to Facebook's September filing:

The table above excludes the 444 million outstanding shares and 60 million shares issuable upon the exercise of an option that are held by Mr. Zuckerberg because he has informed us that he has no intention [Note: This is an intention not a legal requirement] to conduct any sale transactions in our securities for at least 12 months. In addition, as of August 30, 2012, options to purchase 45,693,252 shares held by former employees were outstanding and fully vested and the shares underlying such options will be eligible for sale on November 14, 2012. We expect an additional approximately 4 million shares to be delivered upon the net settlement of RSUs following the date of the initial settlement of RSUs described above and December 31, 2012 will be eligible for sale in the public market immediately following settlement.

"Hijacked" Sponsored Stories Lawsuit: More Trouble Ahead for Facebook?

Facebook reported a loss of $59 million for the third quarter on a GAAP accounting basis. Its revenues were up 7 percent to $1.26 billion, but its costs climbed at an even faster rate. Moreover, Facebook said that its revenues from desktop users sputtered and it was counting on "sponsored stories" to drive revenue growth with mobile users.

But "sponsored stories" may be in trouble, because many users feel the stories were hijacked. Most users are apparently unaware that when they hit a "like" button, Facebook reserves the right to use their images and other information in "sponsored stories." Facebook gets paid by advertisers for this information, but the user gets paid nothing. Some users thought this was an invasion of their privacy and objected that as adults, they cannot opt out.

The lawsuit makes it mandatory for children to now be able to opt out of "sponsored stories." But adults still don't have that option. Facebook proposed changes to its user agreement:

You give us permission to use your name, profile picture, content and information in connection with commercial, sponsored, or related content (such as a brand you like) served or enhanced by us. This means, for example, that you permit a business or other entity to pay us to display your name and/or profile picture with your content or information. If you have selected a specific audience for your content or information, we will respect your choice when we use it.

But Laura Antoninni, a staff attorney for Consumer Watchdog had this to say about Facebook's proposed settlement:

Under the proposed settlement Facebook is poised to continue to misappropriate its users' personal information without their consent. Indeed, Facebook recently expanded Sponsored Stories to its mobile platform, an arena where the misappropriation of personal information has far reaching and potentially dangerous consequences; the proposed settlement does not address this major expansion.

There was supposed to be a hearing on October 25, 2012, the day that Facebook's officers readied their shares for sale, but there has been no public announcement -- that I could find so far --o f the outcome of this hearing.

Facebook has even more trouble in Europe where privacy laws are more stringent. Austrian law student Max Schems has led the charge against Facebook's violations of Europe's data protection laws which prohibit, among other things, certain use of images and permanent storage of user data.

Disclosure: I'm long puts on Facebook.

Also by Janet Tavakoli on Facebook's problems:

"Facebook's Plummeting Stock Price" -- October 16, 2012