I'm getting to this a bit later than planned, but that's okay, because Facebook's share price hasn't done much but go down, down, down for the past few weeks. Observers are even beginning to ask a once un-askable question: Should CEO Mark Zuckerberg be replaced?
Facebook has rallied a bit this morning, recovering from an all-time post-IPO low of $18.75. The company is currently in the throes of the slow-motion end of it's "lockup" period — through next year, early investors and Facebook employees will be able to sell shares in the firm.
The state of California is facing a gigantic budget deficit and has been counting on revenue from the sale of those shares — which are taxed as capital gains — to ease some of the pain. Prior to the Facebook IPO, the Legislative Analyst's Office (LOA) said that California could anticipate a revenue windfall related to investors and employees cashing out.
Emily Raimes of Moody's, the big ratings agency, took a look at this expectation in a note published earlier this month:
The state’s budget for fiscal 2013 assumed Facebook-related revenues of about $1.9 billion over 2012 and 2013...The administration’s revenue projections assumed a $35 share price at the time of the IPO and $35 in November, when Facebook projected significant activity settling restricted stock sales. Since the IPO, Facebook’s share price has fallen below what the state assumed when forecasting its revenues. If the share price rises sharply before November, revenues could increase above the state’s projections. But if the stock price remains low through November, the state could lose hundreds of millions of tax revenue dollars.
I talked to Raimes, who pointed out that with a budget of $91 billion, even losing hundreds of millions to a slumping Facebook share price wouldn't be that big a hit to the state's revenues. She said that the state isn't likely to receive the $1.9 billion it forecasted, but that's not an unmanageable problem. Estimating revenue from capital gains is a tricky business.
"California isn't unique in this," she said. "New York, New Jersey, and Connecticut are also high-wealth states, with high capital gains. They've structured their taxes around this."
But she added that this "makes the overall revenues of California more volatile," creating "huge dips during downturns." And this isn't a positive for the state, from the perspective of the bond markets. "We would say that revenue stability is a credit strength," she stressed. "And that having this kind of structure is a credit weakness."
So why was California tempted to predict a Facebook effect in the first place? The critical issue was the stock's price, which was increased in the days leading up to the IPO and has fallen rather precipitously since then, erasing 50 percent of what was a $100-billion-plus market cap. Jason Sisney of LAO provided me some insight, by email.
"I think it is fair to say that the bulk of market commentary prior to the IPO was on how far the stock would rise, and I think most analysts did not anticipate the subsequent sharp crash in the stock, beginning with its problematic debut on the stock market," he wrote. "Moreover, prior to the IPO, private markets traded Facebook shares around $40 (there were many shares of the stock trading on such markets prior to the IPO). On the other hand, if state revenue estimates would have assumed a drop in the stock price in the months following the IPO, many, many folks would have said that was too pessimistic."
According to Sisney, the LAO and the Brown administration accounted for both outcomes: a Facebook that did even better than expected; and a Facebook that tanked. He also said that the LAO didn't bite on the $40-per-share private-market valuation, preferring a share price of $35. That was probably wise, given that a lot of post-IPO Facebookology has focused on the private markets — exchanges where insiders can trade their shares, free of government regulation — overpricing the company and setting up retail and institutional investors for a big fall.
(Also bear in mind that Zuckerberg didn't want to take the company public, but that once Facebook hit a 500-shareholder threshold stipulated by the SEC, it could no longer keep its financials private and basically had to do the IPO.)
As Raimes indicated, these relatively minor disasters — revenues from Facebook weren't going to represent more than about 1 percent of the total state budget — are part of a larger problem. California is far more dependent on the incomes of the wealthy now than it was in the past. Here's what I wrote about the trend prior to the Facebook IPO:
In California, the wealthiest taxpayers now account for 22 percent of all income, up from around 10 percent in 1980. This messes with forecasting. When times are good, they're very good. When times are bad, the deficit grows and grows and spending cuts plus new taxes — as Brown has proposed — as required.
So in a sense, getting burned, slightly, on Facebook could be a good thing for California. It will show that anticipated big returns from risky industries, if they do materialize, are frosting. We shouldn't be so seduced by the them that we forget about the cake.