Chief Operating Officer Sheryl Sandberg was recently appointed the first female director on Facebook's (FB) board. Her appointment may assuage concerns about corporate governance at Facebook, but unfortunately it is of little consequence. Instead, Facebook must embrace leadership with experience successfully monetizing user groups. Investors should not pay current high valuations for a shift to a better revenue-generating regime that has yet to happen.
Corporate Governance and Healthy Boards
Board diversity is an important indicator of healthy corporate governance, but it can be gamed and is not an end to itself. Ideally, the board would be composed of the best available directors who feel free to express opinions without fear of reprisal or political blowback. The archetypal board would provide honest, sobering feedback to executives who typically only hear "yes."
In contrast, a corporate governance nightmare board of directors would be very different. The board would be composed of cronies of the CEO who are submissive to him or her. They would have been culled from friends, relatives, quid pro quo, and a pool of sycophantic "yes men." Historically, the image of a CEO choosing board members from golf buddies at a country club comes to mind. The image of such all-white "good old boys" is not diverse, and this caricature is inconsistent with board diversity. So diversity in the sense of age, gender, sexual preference, race, national origin, or other categories is often used as an indicator for bad corporate governance. It is an indicator which challenges the scenario of picking board members from the country club.
The critical difference between a healthy board exemplifying good corporate governance and a corporate governance nightmare is a diversity of thought and the moral courage to challenge the CEO. (This is essentially a recipe for shareholder representative government where there are checks and balances and representation for different viewpoints.) The actual diversity in the sense of age, gender, sexual preference, race, national origin, or other categories does not necessarily lead to a diversity of thought. Racial or other diversity is not, in itself, important for strong boards. Minority or female board members can be just as useless and sycophantic as white males. Redundant viewpoints are not as valuable as unique ones. Two heads are only better than one if they think differently.
Mark Zuckerberg's board has many strong voices: Mark Andreessen (venture capitalist and Netscape Communications co-founder), Jim Breyer (managing general partner of Accel Partners), Peter Thiel, (founder of hedge fund Clarium Capital), Reed Hastings, CEO of Netflix (NFLX), and Donald Graham (Washington Post CEO). However, the viewpoints of these executives are likely similar.
This board is heavy on fabled entrepreneurs and under-represents management experience in established companies. This is critical because Facebook's key issue is how to radically monetize its user base. Though this board is a remarkable resource for starting great companies, it is less useful at transitioning existing startups into profit-generating machines. Analysts are increasingly concerned about how Facebook will make money. They are right to be so, and investors should not hold their breath.
Any discussion of Facebook's corporate governance should mention how Mark Zuckerberg has unshakable control. The company's two share classes with differential voting rights give Zuckerberg 57% of voting rights over the firm though he retained a minority 28% stake of Facebook ownership. Though Zuckerberg is a brilliant young man, he is not perfect. Checks and balances are missing from this setup.
Alternative, Profitable Investments in User Platforms
Consider the following companies which derive their income from online platforms:
Growth Next 5 Years
There are dramatic differences in the prices of these stocks. Amazon and Facebook are trading at much higher prices which anticipate incredible growth for the next five years in earnings. Yahoo!, Google, and eBay are trading at prices which are more reasonable considering existing, actual business.
The high valuations of Amazon and Facebook are very different. They both have very high price-to-earnings ratios, but they have very different price-to-sales ratios. This demonstrates that the earnings growth anticipated for Amazon is in part an increase in profit margin. It's fathomable 1.98 price to sales ratio is high for retail, but low for an internet companies and the lowest of those included on this list. In contrast, notice how Facebook's price-to-sales ratio is four times higher than the next-highest price-to-sales ratio on this list. Clearly, the high valuation of Facebook anticipates a surge in sales from Facebook. The difference between Amazon and Facebook is that Amazon has sales and needs to improve profit from those sales whereas Facebook is lacking the earnings and the sales to justify its share price. It needs to grow revenues (and eventually earnings) very, very fast.
The other companies on this list are trading at lower price-to-earnings ratios and should be considered by investors who wish to avoid outlandish valuations. The valuations of Yahoo, Google, and eBay are not attractive in an absolute sense, but they are certainly more reasonable than those of Facebook and Google. This can be seen either through dramatically lower price-to-earnings ratios and price-to-free cash flow ratios.
Investors should also be cautious of Google since, like Facebook, key insiders own a majority of voting rights. Larry Page, Sergey Brin, and Eric Schmidt control 66% of Google's voting rights based on their ownership of Class B shares with enhanced voting rights. Even as a block, outside investors have no means to challenge the direction of Larry, Sergey, and Eric.
Investors committed to the investing in platforms where users can interact, communicate, and trade with each other should consider Yahoo and eBay long before they consider Amazon, Facebook, or Google.