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The big snooze: Facebook and the state budget

To hear some media outlets tell it, the stock price of Facebook is going to make or break California’s budget.

The state estimates income tax revenues of anywhere from $1.5 billion to $2.1 billion from the Menlo Park-based company going public and, in the process, creating several billionaires.

Not the least of which is Mark Zuckerberg, Facebook’s founder, who exercised 60 million stock options worth $2.3 billion.

When shares of the social media giant fell from their $42.05 opening price on May 18 to close at $25.87 on June 5, a spate of coverage predicted dire consequences for the state budget, which already faces a gap between revenue and spending commitments of $15.7 billion.

“Facebook’s underwhelming stock performance could end up spelling trouble for the state of California,” writes Alexander Eichler, a business reporter for The Huffington Post on May 31. “The cash shortfall for California may … end up in the hundreds of millions.”

Facebook declined to comment on the issue to Capitol Weekly.

Television stations, vamping on a May 22 Associated Press story saying “California’s budget could take a hit if Facebook’s stock price keeps sliding,” breathed heavily that the budget hole would deepen based on the fortunes of the eight-year-old social network.

Sure, the budget hole might deepen but in a fiscal year that has a $92 billion general fund and estimated state income tax collections of $60.3 billion:      Ho-hum.

The high end $2.1 billion in tax revenue estimated by the Legislative Analyst’s Office represents just fewer than 3.5 percent of total income tax receipts. The lower $1.5 billion estimate by Gov. Jerry Brown’s Department of Finance, less than 2.5 percent.

“It’s a massive IPO but in terms of being determinative of the overall revenue performance this year and next year its impact is pretty modest. It will be outweighed by broader financial and economic developments,” said Brad Williams, a senior partner with Capitol Matrix Consulting.

“The general direction of the stock market, the strength of wages, unemployment levels, the strength of overall business income  — those are all going to weigh more heavily on the personal income tax total over this year and the next.”

Of course there’s nothing ho-hum about the IPO to Facebook’s executives and employees many of whom will become, at a minimum, millionaires.

A total of nearly 379 million Restricted Stock Units  — RSUs, as they’re commonly called – are owned by Facebook’s 3,000 employees.

Of those RSUs, 240 million are eligible to become shares six months after the date of the IPO.

For example, come November 18 the more than 25 million RSUs held by Sheryl Sandberg, Facebook’s chief operating officer and an employee of the company for four years, will make her a billionaire – if the share price stays at $37 or above. At $35 a share she’d merely be in the high hundreds of millions.

Nothing would please lawmakers and the Brown administration more than for Sandberg to become a billionaire.

The state doesn’t care that Nasdaq didn’t list the stock on time for the IPO or that investors filed a lawsuit claiming Facebook didn’t properly disclose important financial information.

Nor does the state care that Priscilla Chan, now Zuckerberg’s wife, insisted he adhere to a “relationship contract” stipulating at least one date and a minimum of 100 minutes of quality time each week — plus two weeks of vacation abroad annually.

And the state is only peripherally interested that Facebook has 901 million active users, logs 2.7 billion Likes and Comments each day and boasts 100 billion friendships.

California is all Jerry Maguire, all the time: Show the cash-starved general fund the money.

If the stock price is $50 in November state budget writers would be ecstatic. If the price stays around the $32 vicinity where it is now, the Legislative Analyst estimates the state would reap $1.6 billion in tax revenue instead of $2.1 billion.

Both the Legislative Analyst and the Department of Finance say that Facebook’s S-1, the document the company filed prior to the IPO, contains much more specificity than was available for California’s last major IPO.

“This is much different than Google in 2004,” said H.D. Palmer, spokesman for the Department of Finance. “From Facebook’s disclosure documents, we knew how many options Zuckerberg was going to exercise, we knew the universe of stock that would flow to other Facebook employees and we knew the date when all that was going to happen.”

         
In theory, that allows for more precise estimates of the IPO’s impact on state coffers although an examination of the track record of the state’s guestimators over the past two decades finds them in the same boat as King Balthazar of Babylon: Weighed in the balance and found wanting.

The Legislative Analyst and Department of Finance both admit there’s potentially a large margin of error over the ultimate budgetary pluses or minuses of Facebook’s because it’s hard to predict what share price will be six months from now.

“While state revenues could be hundreds of millions below our estimates and the administration’s in some scenarios, the revenues could also be $1 billion or $2 billion above our respective estimates,” the analyst wrote on May 15.

Jason Sisney of the analyst’s office told Capitol Weekly in a June 18 interview:

“State budget forecasts are always based on assumptions — either explicit or implicit — about stock market performance.  What’s unusual this year is that, besides the usual stock market uncertainties, we had this enormous uncertainty about one particular stock.  We know the state will get substantial revenue related to the IPO but the question is how much.  “We still don’t have a precise answer to that. By November, we’ll have a better idea.”   

That uncertainty could be one reason the Department of Finance took a more conservative view of revenue derived from the IPO – always better to have an upside than a downside. 

Facebook’s shares will trade at $35 in November, Finance predicts in its estimates. The department also assumed the stock would initially sell for $35 instead of the $38 it actually did.

Under Finance’s model, the state will receive $283 million in Facebook-related taxes during the current fiscal year that ends June 30 – some $200 million of it from Zuckerberg.

Another $1.2 billion will be received in the next fiscal year, derived mainly from the withholding paid as part of the RSU transactions in November.

If the Democratic governor’s temporary tax increase proposal passes in November with its three higher brackets for the state’s wealthier taxpayers that would yield another $400 million for the state.

That would be gravy. Finance doesn’t count the $400 million in its revenue total.

The analyst takes a less static approach. They assume a $38 IPO price and predict share price climbs to $45 in November yielding $2.1 billion in tax revenue between now and June 30, 2013, the end of the next fiscal year.

A factor considered by both Finance and the analyst  — but not included in their revenue estimates — is what Facebook’s 1,000 shareholders do with the 1.9 billion Facebook shares already outstanding as of December 31, 2011.

Facebook’s S-1 is silent on their disposition.

Most of the shares,
1.1 billion, are concentrated in the hands of company executives, directors and investors holding a 5 percent or greater ownership stake.

There’s a six-month “lock-up” period after the IPO but after that Finance and the analyst hypothesize that the major investors will likely divest themselves of at least some of their holdings. So might executives and other shareholders, just as Zuckerberg swiftly sold 30.2 million of his shares after the IPO for a cool $1.1 billion.

“That presents the possibility for a large amount of capital gains, much of it likely attributable to California residents,” says a Finance memo analyzing the IPO’s revenue effects.

According to one estimate, if 25 percent of that stock is sold and 75 percent of the sellers are California residents with a gain of $25 per share, the state could reap $800 million or more in additional taxes.

A final unknown is the ripple effect the IPO has on the state economy.

With market capitalization of $100 billion and more than $10 billion in income generated for Californians, the IPO represents roughly 20 percent of the state’s estimated 4.9 percent personal income growth in 2012.

And some of that income will be spent on purchases of cars or other big-ticket sales tax items. More money in the pockets of at least 3,000 Californians could also spur real estate sales – particularly in the Bay Area and vacation destinations.

“There are going to be numerous secondary effects from the IPO — some tax planning measures will offset some of the income – but some of those effects may add even more tax revenue,” said Williams.

But, as Sisney says, California will know a lot more Nov. 18.


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