Like? Comment? What the SEC might think of Facebook's IPO
The Facebook IPO is a pretty big deal generally. Whether Facebook would go public stirred media frenzy and Congressional testimony in the past year. Facebook’s initial registration statement indicated it would be the largest tech company IPO ever (the fee table on the original filing showed a $5 billion offering – the filing fee alone was $573k). And the company’s social importance is undeniable.
But what will the SEC staff think about Facebook’s disclosures? Will the path to going public hit some speed bumps? We got our first big clue on Wednesday, when after the markets closed Facebook filed its first substantive amendment to the Form S-1 for its IPO. (It filed Amendment No. 1 shortly after its original filing, solely to add exhibits.)
On interesting deals, I sometimes compare an amended S-1 to the prior filing to see what changed. Seeing what disclosures a company has changed lets me surmise whether SEC comments may have driven the change and piece together the issues the SEC staff has raised with the filing. In a deal like Facebook’s, you can assume the staff heavily, carefully reviewed the filing, so the comments the staff elected to give may reveal points of general SEC emphasis, with potential application to other companies. A deal like this also tends to become a frequently used source for future disclosures by other companies looking for precedents, which makes monitoring Facebook’s disclosures particularly interesting.
Or perhaps that’s just my rationalization – I just couldn’t help but spend a few hours looking at this…
In any event, for kindred spirits, my guess is that Facebook probably received SEC comments clustered around the themes discussed below. For those who do not routinely review registration statements, this post will be fairly technical and you may want to stop reading now.
1. "Controlled Company" disclosure now on cover – Disclosure has been added to the prospectus cover page that Facebook is a "controlled company" under applicable listing rules, and it intends to use the corporate governance exemption for such companies from having an independent nominating committee.
2. Zuckerberg's control – A new section has been added to the box summary that Zuckerberg's control may make Facebook shares less attractive to certain investors. It highlights Zuckerberg's post-IPO ownership percentage, that his ownership level could delay or preclude a change of control transaction, and that his ownership could discourage investors from buying shares due to the limited voting power they would have. It also discusses that Facebook does not intend to have an independent nominating committee. Disclosures regarding Zuckerberg's control were also reinforced elsewhere in the book, such as the risk factor regarding concentrated ownership.
3. Dual-class structure – Facebook reinforced its disclosures on its dual common stock structure as potentially "precluding" new shareholders from influencing corporate matters.
4. “Exclusive forum” provision – Facebook added disclosure that the “exclusive forum” provision in its post-IPO certificate of incorporation, which provides that most corporate law suits brought by shareholders must be brought in Delaware, may be unenforceable. See our prior post regarding these types of exclusive forum provisions.
RSUs tied to IPO
Facebook granted numerous RSUs with vesting tied (1) to a service condition beginning from the date of grant, and (2) to a liquidity event condition, which the IPO will constitute, plus the lapse of 6 months. Facebook did not expense these RSUs at 12/31/2011 (or prior periods) due to the IPO condition not having been met, but it will need to expense a significant cumulative amount for the portion of the RSUs that had met the service condition (but not the IPO condition) at the IPO date. This expense will be a tremendous number, and it seems to me that the staff likely asked several questions about this. For instance:
5. Accounting disclosures – Facebook has:
- Added disclosure that the IPO vesting condition does not affect the expense attribution period (e.g., the expense will still be attributed evenly over the service period, but the IPO condition delays the timing of when this expense is recognized for the portion of service pre-IPO).
- Enhanced the quantification of the expense from RSU awards, assuming the IPO had occurred on 12/31/2011.
- Will state the intrinsic value of the RSUs at 12/31/2011 assuming the IPO price
- Estimated the RSUs vesting and the withholding rate (~45%!), and stated that it is unable to estimate the withholding amount (since it’s tied to value 6-months post-IPO).
- Clarified that, if the service condition has been met, but the "six months from liquidity event" condition has not been met, those RSUs are not forfeitable, and the six-month wait post-IPO is not a "substantive service condition."
6. Liquidity disclosures – Facebook discloses that, last month, it terminated its prior $2.5B credit facility and entered into (1) a new $5B facility (only $2.5B available until IPO closes), and (2) a new $3B revolving credit facility "to fund tax withholding and remittance obligations" related to settling the RSUs it granted with vesting tied to the IPO – that is a lot of withholding!
7. Compensation disclosures – In CD&A, the deferred vesting schedules of RSUs are stated more specifically, and the “initial equity value” of the RSU awards are quantified.
8. Reliability of data – Facebook provides metrics throughout the prospectus that it generates from its internal records, such as daily active users, monthly active users, and mobile users. Facebook added several disclosures, including reinforced disclosures in the "Industry Data" section and a new standalone risk factor, regarding how its internally generated numbers may be unreliable or inaccurate, such as if users have duplicate accounts or if Facebook’s mobile apps that automatically ping its servers are doing so for inactive users.
9. User Metric Trends – Facebook’s original MD&A began with a discussion of user trends. In the amendment, there are several changes to make this discussion more specific and connected to financial performance. Facebook now:
- Adds disclosure regarding year-over-year changes in user metrics, the drivers of those changes, and how the change may impact revenues.
- Adds disclosure regarding growth of mobile users, given that mobile users historically generate no ad revenue, although there are new efforts underway to change this. Also discussed that increased mobile growth may tend to slow PC user growth, which may slow revenues.
- Breaks down increases in user penetration rates by geographic region.
10. Monetization by Geography – Facebook added new discussion of trends in monetization by geographic region.
11. Factors Affecting Performance – Facebook added several factors affecting growth, including user growth, increases in mobile users (unproven ad revenue in this space), and how to make ads more valuable.
12. Share-based compensation – The original S-1 had a lengthy discussion of share-based compensation. A well known and sensitive disclosure topic in an IPO, perhaps it is no surprise to see several changes here:
- Placement of Discussion: Within MD&A, this was advanced forward in location to the Factors Affecting Performance section (it had been slightly later in Components of Expense).
- Valuation methodology: Previously disclosing the use of several valuation methods to determine fair value of awards, Facebook has now added the percentage weighting assigned to each method and an explanation of why that percentage was assigned.
- Chronological break down of award value: The previous quarterly presentation of award values for 2011 has now been further broken down by month, including methodology disclosures for such months.
13. Quantification in MD&A – Facebook added disclosures to quantify when multiple factors contribute to a period-over-period change. For example, it added new disclosure in cost of revenues discussions that quantifies the effect of depreciation, rent, and processing fees.
14. Deferred revenues and deposits – Facebook added disclosure to separate out deferred revenues from deposits, explaining what each represents separately and quantifying them.
15. Peer group/Benchmarking – Facebook presented the revenue range for the peer group it uses, and clarified that it does not employ targets for most aspects of its award decisions.
16. Use of Discretion – Facebook added in several places that its compensation committee makes “qualitative assessments” based on listed factors, without preset ranges.
17. Calculation of NEO cash bonuses – details were added regarding individual cash bonus calculations, including a table setting out awards by person.
Related party transactions
18. Identifying affiliates – Facebook has named the affiliates involved in the agreements rather than only naming some parties (with an "and other parties" catch-all).
19. Terms of agreements – Rather than saying certain agreements were on "commercially reasonable terms," Facebook now specifies agreements that use its online general terms and conditions. If terms were specially negotiated, Facebook added disclosure regarding the negotiation process, such as the non-involvement of potentially conflicted insiders in the negotiation. Facebook also made these changes in related sections (e.g., the Reg Rights Agmt is also discussed in Description of Capital Stock).
Miscellaneous other possible comment areas
20. Zynga risk factor – in the risk factor regarding Facebook's reliance on Zynga for revenues, Facebook has added that Zynga has launched games on non-Facebook sites. One wonders if the Staff cross-compared Zynga's disclosures with Facebook's and noticed a few minor inconsistencies (or if Facebook is monitoring Zynga's disclosures).
21. Identification of industry sources – throughout the prospectus, previously unnamed industry sources have been identified, and related disclosures attributed to those sources have been rephrased in various ways. One presumes the staff has asked Facebook to supplementally provide its backup materials to the staff, keyed to its disclosures.
22. Specific examples and quantification – In several places, Facebook injected specific examples of a disclosure point. For example, it quantified the number of users using Facebook Payments. As an example of possible IP litigation, Facebook added disclosure that last month Yahoo! sent Facebook a letter alleging that a number of Facebook products infringe the claims of 13 of Yahoo!'s patents.
23. Beneficial Ownership Table – the footnotes for Goldman and T. Rowe Price regarding who at these entities has voting and dispositive power have been expanded (but do not name specific individuals…).
It is difficult to say if all of these changes were in response to SEC comments, but my guess is that a large number of them were. It is also possible that Facebook received other SEC comments for which it is explaining its position to the staff rather than revising its disclosures. When the next amendment is filed, we can again compare filings and see if we can identify any additional possible issues.