Facebook Wobbled – But Still Standing

 In Market and Investment Insights

The pronounced decline of Facebook’s stock is a reminder that the Internet landscape is constantly evolving and companies must be nimble.

Key Takeaways

  • Facebook’s share price slid due, in part, to lower margin guidance and a softer revenue outlook. Lower margins reflect increased investment activity in areas such as privacy and artificial intelligence
  • There is the possibility that new privacy regulations may benefit incumbent, Internet companies
  • We believe Facebook is in transition, shifting from traditional sources of revenue to newer platforms that have yet to be fully monetized

Today’s decline in Facebook’s share price justifiably caught the market’s attention. Yet it also provides an opportunity to discuss the state of affairs of the social networking giant – and that of mega-cap Internet stocks as a whole – given recent industry developments. At first glance, a 20% drop in stock price that shaved off roughly $113 billion in market capitalization could be construed as a harbinger of doom. While not that dour, we do recognize the headwinds that Facebook and other advertising-based business models face.

The European Union’s recent implementation of more stringent privacy regulations highlights the challenges faced by ad-based Internet businesses. From a stock perspective, the beneficiaries appear to be subscription-based Internet companies. Still, despite Facebook’s self-inflicted data privacy crisis from last March, user growth remains relatively resilient. While global daily user growth slightly missed consensus estimates for the recently completed quarter, it remained above 10%, year over year. Not surprisingly, Europe was the region with the weakest user metrics.

We view any potential hit to user engagement and earnings growth to mega-cap Internet companies on account of Europe’s General Data Protection Regulation (GDPR) and other possible privacy initiatives as likely ephemeral. Larger, incumbent firms may ultimately be net beneficiaries of such initiatives as they have the resources to ensure compliance, while smaller, challenger platforms may find the new regulations especially onerous, if not insurmountable.

Rather than saying the social media market is maturing, we prefer to describe it as transitioning. As existing sources of growth – in Facebook’s case, its core Newsfeed product – cool and consumers use the platform in new ways, management teams must cultivate new revenue streams. The industry has been through this before, namely with the shift from desktop to mobile. During that period, many naysayers predicted the worst.

This time around, Facebook has several potential growth levers it can pull. We expect management to increase monetization in heretofore underutilized assets, including its newer Stories product, Messenger, WhatsApp and video efforts. Facebook has had a series of false starts on the latter front, but the company has taken steps to make another run at it, this time using its popular Instagram franchise.

“Overreaction” is too strong of a word to describe today’s move in Facebook’s stock. The market does have legitimate concerns, but perspective is necessary. Much of the revenue slowdown in the second quarter was from foreign currency as it has shifted from a tailwind to a headwind. The decrease in operating margin guidance also requires context. The company has been vocal about its investment plans, not only to create more robust privacy and security infrastructure, but also to deploy artificial intelligence throughout its business model to help drive efficiencies. Such investment, in our view, is yet another example of how Internet companies must constantly adjust their business models to account for an evolving landscape.

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