Facebook’s IPO And The Q’s

April 26, 2012

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Nasdaq turned heads a few weeks ago when it made some changes to its index rules, because everyone felt it was all about Facebook’s IPO. But look before you leap.

The No. 2 U.S. exchange cut to four months the “seasoning” criteria from two years and from one year for securities with market caps in the top 25 percent of the index.

Beginning on Monday, April 23, any company that’s been listed on Nasdaq, NYSE or NYSE Amex for at least three full months is eligible to be added to the Nasdaq 100 Index. But Nasdaq’s three-month count doesn’t begin until after a company’s first month being listed is over, meaning that what really talking about is a four-month seasoning period.

Like I said, many have speculated that this rule change was enacted specifically to enable the addition of Facebook, whose initial public offering is expected on May 17.

Facebook is expected to IPO at a valuation of $100 billion, which would make it the eighth-biggest company in the Nasdaq 100 and therefore the No. 8 holding of the $32 billion PowerShares QQQ Trust (NasdaqGM: QQQ) that tracks it.

Unfortunately for Facebook fans, the story is a bit more complicated than that. But first some background …

Two Classes Of Stock

After the IPO, Facebook will have two classes of common stock—A and B. Only Class A shares will be listed publicly, with most of the rest of the shares—Class B—remaining privately held.

According to the latest Facebook prospectus, filed this week:

“The rights of the holders of Class A common stock and Class B common stock are identical, except voting and conversion rights. Each share of Class A common stock is entitled to one vote. Each share of Class B common stock is entitled to 10 votes and is convertible at any time into one share of Class A common stock.”

The prospectus doesn’t yet indicate the percentage of voting power that is/will be allocated to Class A and Class B shares, but it does note that Facebook is a “‘controlled company’ under the corporate governance rules for Nasdaq-listed companies.”

That basically means that more than 50 percent of the voting power for the election of directors is held by an individual, a group or another company.

That individual, of course, would be Facebook Chief Executive Officer Mark Zuckerberg. Kathy Kristof, in a CBS MoneyWatch article, calculated that Zuckerberg has 57 percent of the voting control and owns 28 percent of the stock.

Nasdaq weights index constituents based on the market capitalization of the security, rather than the issuing company. That means that Facebook’s weight in QQQ will be determined by the market capitalization of the A shares that will be sold to the public next month.

Too Small A Piece In Public Hands

Considering that Facebook is supposedly planning to debut about $10 billion of its $100 billion market cap in its IPO, it’s probably a good guess that the A shares will be worth something close to $10 billion.

Of course, that number could grow if Facebook employees convert B shares into A shares for sale on the open market.

Still, at a $10 billion market cap, Facebook would still be added to the Nasdaq 100 and the Q’s, but at a much more muted weight. Rather than being the 8th-largest company with a weight of approximately 3 percent, it would be around 60th largest, with a weight around of 0.33 percent.

As cool as it is that Nasdaq changed its rules for easier access to Facebook, I’m not sure it makes sense to wait four months and then rush out and buy the Q’s for a 0.33 percent exposure to Facebook.

If you want exposure to Facebook, just buy it outright. Or wait for it to pass the minimum seasoning periods for the focused technology and Internet ETFs.


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