Facebook's $2B buyback: Win some, lose a lot

(MoneyWatch) Facebook (FB) filed paperwork with the SEC to announce a complicated set of upcoming transactions that, according Henry Blodget of Business Insider, translates into a backdoor $2 billion stock repurchase.

He's right, although his focus on the strategically smart maneuver doesn't mention a possibly bigger reason for the dance: Given its stock price, Facebook has to do everything it can to reduce the number of shares that suddenly hit the market this fall.

First, here are the actions the company will take, according to the SEC filing. Don't get caught up on any one step, as it is the combination that is telling:

• Company directors Marc Andreessen and Donald Graham sell stock to pay taxes on their stock awards.
• After cashing in to the tune of $1.1 billion at the IPO, Mark Zuckerberg will not sell any shares for at least a year.
• Employees who were not to be allowed to sell their shares until mid-November will get to do so by the end of October, four trading days after the company releases its third quarter earnings announcement.
• There are 234 million shares owed to employees. Facebook will hold back 101 million shares to cover taxes, but will actually pay the tax bill with cash.

Sound confusing? It is only on the surface. Instead of seeing employees sell shares to cover the taxes that come due, Facebook buys those shares at $19 each, retiring them from circulation, with the cash going directly to tax authorities rather than indirectly through the employees. It's a stealth buyback. The question is why.

As Blodget points out, "Smart companies sell stock when it's expensive and buy it back when it's cheap." And Facebook is getting those shares at half the IPO price.

But there's something else going on. Perhaps the most hyped high tech company in history, its IPO price of $38 per share reflected a public valuation of $104 billion. Then came a series of problems, starting with NASDAQ's systems problems that delayed many orders by hours and continuing with the news that some of the investment bankers had tipped favorite investors with concerns about Facebook's revenue prospects going forward. That ultimately resulted in lawsuits being filed against Facebook and its investment bankers, regulatory agency investigations, and a stock price that has dropped by more than 50 percent.

Investor confidence has taken an enormous hit. Ironically, Morgan Stanley, a lead underwriter in the company's IPO, just downgraded the stock and cut its price forecast over concerns of how well Facebook will be able to make money off users who gain access through mobile devices.

There's also been a big concern among investors about the enormous amounts of shares that employees hold. More shares invoke the law of supply and demand. As supply increases, share prices drop.

Facebook must keep as many additional shares off the market if it is to see its stock price again rise. But the company can't keep employees locked up forever. Their shares are part of their compensation, and unilaterally extending the period during which they can't sell would probably be illegal. At the very least, it would enrage employees, whom Facebook needs, and create a nor'easter worth of bad PR. And the stock has provided enough bad publicity to last many fiscal years.

However, by moving up all these transactions to right after the third quarter results are out, Facebook restricts the damage to a single shot (assuming that the numbers won't look as good as so many want them to be) and minimizes the number of shares that hit the market, taking at least some pressure off.

Ironically, should Facebook's fortune significantly improve, the buyback could prove a windfall because the company would pay a discounted rate. On the flip side, a downward move in price would saddle Facebook with the loss.