Lessons in Meta, the Metaverse, and Corporate Governance - Part 1
[Metaverse HQ - 1 Hacker Way, Menlo Park, California.]Meta, formerly a $1Tn company, has been having a poor time this year. Its shares, as of Nov 10, are down 67% YTD, shedding a whopping $600bn in market capitalization in 10 months. Recently, they've been forced to lay off thousands of employees. While Meta's not alone in the myriad of problems now facing many technology companies, and it's definitely not the most battered name in tech this week (does that distinction go to Twitter or FTX?), Meta is unique in the common perception that its biggest problem seems self-inflicted: namely, its vast capital spending on the Metaverse.
There is little doubt that Meta is facing big problems, but what can shareholders, stakeholders, or employees do about it? The short answer- seemingly not very much! The slightly longer answer is similar, but requires a little bit more explanation about Meta's leadership structure, dual-class share structure, and a bit of corporate governance theory. Let's delve in.
Meta is Facing a Shareholder Rebellion
Long-time shareholder Brad Gerstner's recent open letter to Meta captures the prevailing zeitgeist of investor opinion: Meta is committing $10-15bn a year for a decade into a segment that currently generates >$1.5bn in revenue, and investors are fuming. For good reason too: last quarter, its Reality Lab segment's sales fell ~50% YoY due to a reduction in sales of its Quest 2 headset. This is despite core challenges to the business which have led to stagnant sales growth, including competition from TikTok, Apple's recent ecosystem changes, and headwinds in the ad space. Yet, Meta is still expecting to spend >$30bn in CapEx spending this year, while its annual R&D spending has increased by a factor of 1.5x. The inevitable conclusion of less money in, more money out, is a weaker bottom line: free cash flow YTD has fallen 48% YoY.
Yet, Mark Zuckerberg seems to disagree with his shareholders. He talked pretty extensively about the metaverse in Meta's most recent earnings call:
“There's still a long road ahead to build the next computing platform, but we are clearly doing leading work here. This is a massive undertaking and it’s often going to take a few versions of each product before they become mainstream. But I think our work is going to be of historic importance and create the foundation for an entirely new way that we will interact with each other and blend technology into our lives, as well as a foundation for the long term of our business.”
I'm not going to opine on the viability and future applications of the metaverse here; namely, because I've been really wrong before! The general consensus seems to be that it's coming but it's far away, but I think only time can really tell. What I can look into is how fascinating a future MBA case study this will be: one that won't discuss who's right per-se, but who gets to be right, and far more interesting- who should be right?
Lessons in Corporate Governance
Let's start with some facts. As of Dec 2021, Zuckerberg owned 13.6% of the company, consisting mostly of his 366mn shares of Class B Common Stock, out of a total circulation of 2.3bn Class A shares and 412mn Class B shares. Class B shares, which are not tradeable in the public markets, are worth 10 votes per share in stockholders' meetings, versus a mere 1 vote per Class A share. Quite simply, Zuckerburg, through Meta's dual-class share structure, has complete control over his company with more than half its total voting power. As Chairman and CEO, this seemingly gives Zuckerberg a free hand in running the company and its operations - which doesn't bode well for Class A shareholders seeking to change direction on his Metaverse project.
Notably, Meta also has quite an institutional shareholder base. As of August, the top five institutional shareholders owned ~25% of Meta, and included names like Vanguard, Fidelity, and Blackrock- all large long-only asset managers. Surely, sophisticated investors such as these would fight for a greater say in Meta's affairs? Yet, it is generally smaller investment managers, such as these, who push for shareholder proposals to remove the dual-class share structure- an idea that is predictably shot down by Zuckerberg year after year since Meta has gone public. Larger shareholders seem more willing to rubber-stamp his Board of Directors nominees, many of whom have been accused of lacking real independence in their ability to oversee the management team and properly protect shareholder interests, in exchange for a more subtle influence on Meta's future direction. The only other alternative for many investors is to sell their stake, which has clearly taken its toll on Meta's share price and multiples.
Zuckerberg in his function as CEO, and the Board of Directors as representatives, both have a clear fiduciary duty to maximize value for shareholders. Legally, this fiduciary duty usually involves a duty of care and a duty of loyalty- that directors and officers of the company make informed, material decisions based on all reasonably available information, and do so in a way that does not further their own private interests. Zuckerberg has lost billions this year; I think few will argue that he has gained personally from his pursuit of the metaverse. Even fewer could say if a CEO can ever be convicted for a bad business decision- as long as it was an informed bad business decision.
The curiosity is that, despite breaking no laws and no rules, we have a situation where the vision and direction of a corporate leader differs so strongly from that of its shareholders, and the shareholders can do very little to rectify that situation. This situation really digs into the classic notion of shareholder primacy- the theory that maximizing shareholder interest is the primary purpose of the corporation. While few could claim that shareholders didn't know the devil's deal they'd be getting themselves into, I'll recognize that when times are good, nobody really questions what successful managers do.
That said, shareholders can still try the courts in very innovative ways. In Part 2, I'll discuss the class-action lawsuit filed against Meta last month, and what else we can learn from Meta, plus a few additional thoughts on dual-class share structures versus fiduciary responsibilities and shareholder primacy.
I know that Meta is not alone in its controversial relationship with corporate governance. Google famously has 3 share classes, and its founders can still exert effective voting control in a similar way to Meta's. But Zuckerberg is still at the helm of his company- running its day-to-day operations as CEO- and sits as one of the most classic examples of a successful dropout founder whose tenure now runs nearly 2 decades (nearly as long as Bill Gates's run at Microsoft).
Zuckerberg has sole reign at Meta, and only a select few can say they alone control one of the largest companies in the world. But Zuckerberg also seems to see his interest in Meta's future as the shareholder interest, and his voting control ensures that. For public shareholders, asset managers, as well as stakeholders like employees, the message seems to be: you're either with my vision, or you're free to get out. I know many are choosing the latter.
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