Revealed: How Facebook ‘gave officials inflated estimates of the number of its users’ just a week before disastrous IPO

  • U.S.  Securities and Exchange Commission had to fight Facebook on 92 queries it had  regarding plans for its May 2012 IPO which it filed on February  1st
  • Correspondence between the SEC and Facebook show that  Facebook was unable or unwilling to share details of its business plan with the  Federal Agency

By James Nye

PUBLISHED:15:24 EST, 10  October 2012| UPDATED:17:22 EST, 10 October 2012

Facebook was caught out providing U.S.  Securities and Exchange Commission officials inaccurate and inflated estimates  of the number of its users and ultimately its worth just a week  before the  company’s disastrous IPO, it emerged today.

A flurry of 12 letters between the U.S.  Securities and Exchange Commission (SEC) and Facebook depict a reluctant  management team repeatedly playing cat-and-mouse over official requests to  release figures and in the end being forced to withdraw information that was in  reality guess work at best.

Most damning is the suspicion that Facebook  did not have accurate figures for the number of smartphone users who use its  application and intentionally held back the real, significantly lower figures,  until only a week before the $104 billion IPO on May 18th.

 

Amateurish: Facebook CEO Mark Zuckerberg speaks to the TechCrunch Disrupt SF 2012 conference on September 11, 2012 in San FranciscoAmateurish: Facebook CEO Mark Zuckerberg speaks to the  TechCrunch Disrupt SF 2012 conference on September 11, 2012 in San Francisco

This information has come to light after the dozen letters dating  from February  1st through to May 17th,  were published on the  SEC’s website 20 days after the  company’s initial public offering.

The contentious exchanges were over  Facebook’s apparent failure to disclose the exact figures for mobile phone user  growth, where they were geographically located, and how it planned to make money  from them.

This has led some analysts to conclude that  Facebook knew their valuation and business plan wasn’t watertight before  launching at $38 a share and that the company should have postponed the public  offer.

‘They were given the benefit of the  doubt  when they went public that they were ready for prime time,’ said  Michael  Pachter, a managing director at Wedbush Securities Inc.

‘They still haven’t proved that they  are.’

In the initial IPO filing from February 1st,  the company said smartphone usage of Facebook increased around the world and  numbered 425 million ‘monthly active users’ in December 2011.

It accepted that it hadn’t proven it could  ‘monetise’ individuals using only mobile devices, where the absence of ads may  ‘negatively affect our revenue and financial results.’

The SEC asked for a ‘more detailed’ analysis  of these key challenges requesting to see the company’s plan B should their  attempts to corner the mobile market fail – an eventuality which the SEC  described as being ‘disastrous.’

Replying on March 7th, Facebook’s lawyer  Jeffrey Vetter disclosed that Facebook’s mobile monetisation strategy could run  up ‘excessive expenses’ but still refused to number the users who ‘primarily  accessed’ Facebook through their smartphone, saying they didn’t have a  ‘reliable’ count.

Disastrous IPO: Facebook CEO Mark Zuckerberg speaks to the TechCrunch Disrupt conference four months after the firm's shambolic share offeringDisastrous IPO: Facebook CEO Mark Zuckerberg speaks to  the TechCrunch Disrupt conference four months after the firm’s shambolic share  offering

When asked by the SEC to locate  geographically its users it said that it couldn’t do so reliably, because for  instance Facebook counted most BlackBerry owners as Canadian because their  servers are based in Canada.

This prompted the SEC to question whether  Facebook actually had 845 million individual users at the start of 2012 which  the firm replied they believed was ‘reasonably accurate.’

They reveal a volley of messages between the  commission, Facebook’s Chief Financial Officer David Ebersman and their law firm  Fenwick & West LLP and show that Facebook was aware of many of the issues  currently unnerving investors.

Central to these correspondence were the  claims that Facebook made on February 1st that their mobile figures were backed  by audience share accounting firm Nielsen and highlighted their ability to  utlilise the burgeoning smartphone market – on which advertisement’s are not as  easily viewed as on a home computer or laptop.

The U.S. Securities and Exchange Commission had to fight Facebook tooth and nail on 92 points of information it wanted to see ahead of its May 2012 IPOThe U.S. Securities and Exchange Commission had to fight  Facebook tooth and nail on 92 points of information it wanted to see ahead of  its May 2012 IPO

Barbara Jacobs, an assistant director for  corporation finance at the SEC was skeptical that Facebook could deliver on  these claims and questioned where they had drawn their figures from after the  Internet company cited respected Nielsen as their source.

After an ultimatum for Facebook to produce a  Nielsen backed study, the social networking firm dropped the reference and  admitted the claim was drawn from marketing materials only and subsequently  ceased to mention them on February 28th – 27 days  after it filed its  proposal to go public.

Bloomberg  News has trawled through the letters  and correspondence and noted they show Facebook executives holding back crucial  details which are only revealed when the SEC pushes for their  disclosure.

In one exchange, the SEC notes that Facebook  in some cases was counting mobile users twice and Jacobs wrote on March 22nd,  ‘Please explain to us how you determined that your metrics are not  overstated?’

Fallen since May: Today's Facebook share - which is around 45 percent down on the $38 dollars it opened at in MayFallen since May: Today’s Facebook share – which is  around 45 percent down on the $38 dollars it opened at in May

Furthermore, on May 9th, eight says before  the IPO, Facebook finally made clear to the SEC that daily mobile customers were  increasing faster than the advertising revenue growth – thereby revealing a  shortfall in the expectations of the much vaunted and imminent  IPO.

Even though the exchanges are now months old,  the issue is more relevant now than before, as the Menlo Park, California based  firm how counts one billion users worldwide.

This is up from 845 million at the year’s  start and of which the firm claims 600 million access Facebook through their  mobile device.

Since their disastrous IPO, Facebook has  dropped to almost a half of its offering price, amid concerns over its ability  to monetise the growing mobile market.

Mark ZuckerbergFaceplant: Mark Zuckerberg on May 18th – the day of the  Facebook IPO

Other’s are just as critical.

‘We’ve been growing increasingly skeptical of  some of their monetisation methods,’ said Richard Greenfield, an analyst at BTIG  Research to Bloomberg Television.

What investors who bought up Facebook shares  in May did not have a chance to see until a month after the IPO were requests  from the SEC that pushed Facebook to disclose how they planned to deal with  challenges they faced such as decelerating revenue growth, user count and its  growing dependency to online gaming firm Zynga Inc.

Current SEC policy is to not release any  messages regarding IPO’s until 20 days after the share float.

However, the revelations that Facebook itself  was unsure of its own figures and busines plan has led industry experts to  question why the IPO occurred at all.

‘When you have a significant change in your  forecasts it’s good business practice to postpone the IPO so that the market has  more time to understand what’s going on,’ said Luigi Zingales, a finance  professor at the University of Chicago’s Booth School of  Business.

Indeed, following the depth of the bungled  IPO, the SEC is continuing to probe an ‘in depth review of all the participants’  in the IPO said SEC Chairman Mary Shapiro in an interview in  September.

FacebookCleaning up: Facebook’s IPO has caused a mess  that is  currently being investigated by the Senate Banking Committee,  two regulatory  agencies and the state of Massachusetts

The Senate Banking Committee is also looking  into the matter, and has held meetings “with a range of involved parties  including Facebook, Nasdaq, Morgan Stanley (MS), and the SEC,” said Sam Gilford,  press secretary for the Senate committee, in an e- mailed statement to Bloomberg  News.

So, while questions may be asked as to why  the SEC allowed the Facebook IPO to go ahead, even with concerns, the heart of  the matter is growing concern within the SEC over how it audits new high-tech  consumer internet firms.

Among the 92 of concern that the SEC brought  to Facebook was the social networking giants reliance on Zynga, which makes the  five most popular games played on Facebook, including ‘Texas HoldEm  Poker.’

At first Facebook told the SEC that Zynga  accounted for 12-percent of its 2011 revenue but after deeper questioning  admitted that Facebook made almost one fifth of its revenue through  Zynga.

In addition, the SEC had to force Facebook to  admit that Zynga could end up becoming a competitor.

‘Zynga may choose to try to migrate users  from existing Facebook-integrated games to other websites or platforms,’  Facebook disclosed.

Times SquareHyped: The Facebook IPO was one of the most  widely-anticipated stock offers in recent history

As a result, ‘Our financial results may be  adversely affected,’ it said.

All answers to the SEC from Facebook were  signed by Jeffrey Vetter, 46, of the Mountain View, California, law firm Fenwick & West. He declined to comment.

The SEC also asked Facebook why it hadn’t  included data on revenue generated by each user, a ‘key’ indicator of  performance.

Vetter dismissed the request on March 7,  saying that the company prefers to look at ‘overall growth in users’ and  ‘overall revenue in evaluating the business.’

Undeterred, the SEC carried out their own  calculations, which made Facebook file the required figures.

These showed revenue worldwide from each  active user falling to $1.21 in the fourth quarter of 2012 from $1.38 in the  fourth.

They also revealed that per-user revenue was  lowest in Asia, at just 53 cents down from 56 cents in the first  quarter.

Company executives did little to help their  cause among shareholders during Facebook’s first months as a newly public  company according to financial experts.

‘There should be more public appearances by  the CEO, there should be ongoing media relations activities that help give  confidence to investors,’ said Paul Argenti a professor at Dartmouth College’s  Tuck School of Business in Hanover, New Hampshire.

‘I don’t see any of that going on. I see the  exact opposite. It’s amateurish.’

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