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Facebook's market debut last week in the US raises comparisons in the New Zealand context with Trade Me’s IPO in November last year.
This Brief Counsel compares aspects of the relevant disclosure documents, and offers some observations on the differing approaches to risk factor disclosure.
The IPOs of Facebook and Trade Me have attracted widespread interest and media commentary, not least because both companies have a history of innovation and rapid growth in their respective markets.
And, although they operate different business models, both invite the same fundamental question: will their current market dominance be diminished by competitors or new technology, given the constantly changing nature of the internet and online interaction?
In light of these parallels, it is interesting to compare the risk analysis relating to each IPO - particularly given the on-going reform of New Zealand’s capital markets regulation and the revised Guidance Note on effective disclosure which the Financial Markets Authority released last month.
It should be noted at the outset that both disclosure documents are consistent with prevailing market practice in their respective jurisdictions.
Current New Zealand law requires an investment statement to contain a brief description of the ‘principal risks’ related to the investment, and an equity IPO prospectus to contain a description of ‘special trade factors and risks’ that are not likely to be known or anticipated by the general public, and could materially affect the prospects of the issuing group.
Nothing in this Brief Counsel is intended to imply that Trade Me’s disclosure does not comply with these requirements or is in any other way deficient.
Facebook’s S-1 filing to the U.S. Securities and Exchange Commission contains 39 separate risk factors related to Facebook’s business and to the industry in which it operates, taking up over 17 pages.
Most of these risks stem from the fact that 85% of the company’s revenue in 2011 related to third party advertising on Facebook – unlike Trade Me, which derives most of its income from fees charged to its community of members.
Around half of Facebook’s users access the website through mobile devices. Yet, not only has Facebook historically not served ads in its mobile applications but, perhaps even more fundamentally, it does not control the mobile operating systems that it will rely on for increased user growth and engagement.
Facebook’s disclosure is clear about these challenges:
...However, we do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven... If users increasingly access Facebook mobile products as a substitute for access through personal computers, and if we are unable to successfully implement monetization strategies for our mobile users, or if we incur excessive expenses in this effort, our financial performance and ability to grow revenue would be negatively affected.
...There is no guarantee that popular mobile devices will continue to feature Facebook, or that mobile device users will continue to use Facebook rather than competing products. We are dependent on the interoperability of Facebook with popular mobile operating systems that we do not control, such as Android and iOs, and any changes in such systems that degrade our products’ functionality or give preferential treatment to competitive products could adversely affect Facebook usage on mobile devices...
The S-1 also includes a specific risk factor on Facebook’s relationship with Zynga which, again, pulls no punches:
In 2011 and the first quarter of 2012, Zynga directly accounted for approximately 12% and 11%, respectively, of our revenue, which was comprised of revenue derived from Payments processing fees related to Zynga’s sales of virtual goods and from direct advertising purchased by Zynga. Additionally, Zynga’s apps generate pages on which we display ads from other advertisers; for 2011 and the first quarter of 2012, we estimate that an additional approximately 7% and 4%, respectively, of our revenue was generated from the display of these ads...If the use of Zynga games on our Platform declines for these or other reasons, our financial results may be adversely affected.
Trade Me’s disclosure on risk factors is more concise – two pages comprising 14 Trade Me Group specific risks in total. Compared to Facebook, Trade Me’s risk factors tend to focus on broad trends, rather than specific competitors or technology challenges, and there is less emphasis on specific sources of revenue. Consider, for example, the risk factors below which deal with the threat of disruptive models or technology changes, and changes in consumer habits:
Emerging technologies may create additional competition in the future. Online and mobile technology continues to advance and this may affect Trade Me’s ability to retain its existing community of members, maintain and increase its existing level of listings, or implement its growth strategies...Competitors may take a different approach to Trade Me in relation to technology changes and thereby secure an advantage which could adversely affect Trade Me’s financial performance.
... In addition, a significant portion of Trade Me’s revenue is derived from advertising as it takes advantage of the continued shift away from traditional mediums like print and radio. However, if the expected trend toward online advertising did not materialise, this could also have an adverse effect on the Group.
Facebook, by contrast, is at pains to spell out exactly where it perceives its competitive threats to lie (mentioning Google+ and other competitors by name, and explaining its reliance on Android and iOs), and is specific as to certain sources of revenue (e.g. Zynga).
This may well reflect Facebook’s dependence on advertising revenue and particular customers such as Zynga, and clearly identifiable, specific threats to that revenue source, compared with the more “generic” threats facing Trade Me.
Chapman Tripp comments
The Trade Me and Facebook comparison illustrates some of the differences in the approach to risk factor disclosure in New Zealand and the United States. Whether one approach is ‘better’ than the other is a difficult question.
The U.S. approach may reflect the audience (predominantly investment advisors and other professionals, as opposed to the primarily ‘mum and dad’ audience for many New Zealand prospectuses), and the much higher risk of investor class actions in the U.S. than in New Zealand.
It also reflects the much larger dollar figure involved. There is little doubt that the cost of preparing the Facebook S-1 will have dwarfed the cost of preparing the Trade Me prospectus. Would there have been a Trade Me IPO at all if it had involved comparable costs?
For the New Zealand market, the key issue is whether current practice adequately advances the twin objectives of alerting potential investors to specific risks, and protecting the issuer from risks of liability based on misstatements or omissions in disclosure documents.
Whether these objectives are achieved will very much depend on how the FMA, issuers and their advisers interpret the FMA’s proposed good practice guidance that disclosure documents be “clear, concise and effective”. This standard is the proposed new test in the Financial Markets Conduct Bill.
Our thanks to Jarrod Murphy for writing this Brief Counsel. Before rejoining Chapman Tripp in 2011, Jarrod practised as an Associate at the leading New York law firm of Cravath, Swaine & Moore LLP. For further information, please contact the lawyers featured. Email firstname.lastname@example.org