Facebook bloodbath a value opportunity
The cambridge analytica data misuse and Trump’s China tariffs have led to the public execution of Facebook shares (160 as I write) for a lost $75 billion in market cap last week. The scandal has done serious damage to Facebook’s brand, the credibility of Mark Zuckerberg and his senior management team and its advertiser driven revenue model. The free-fall in the shares reflects the fact that Wall Street now expects a Federal Trade Commission investigation of the scandal and a regulatory backlash from Washington DC — and even the European Commission. I cannot but help think about Harvard economist John Kenneth Galbraith’s concept of “countervailing power”. Facebook’s vast data trove on the personal lives of 2 billion human beings makes it a digital advertising colossus (with Google) but also a symbol of populist resentment and angst over data privacy violation issues.
Trust is a fleeting commodity in cyberspace, a scandal like Cambridge Analytica can and has damaged Facebook’s brand and increased the odds that its senior management will be publicly pilloried by Congress and regulatory agencies in Washington. So it is entirely rational for investors to dump their Facebook shares. Yet Facebook is a global social media network that has literally transformed human communications on a scale only achieved by Johann Guttenberg, Samuel Morse and Alexander Graham Bell, has been a superlative investment since its shares bottomed after its IPO in the autumn of 2012.
The toxic political climate in Washington DC only amplifies Facebook’s brand damage. Cambridge Analytica, after all, is a voter-profiling and political consulting firm affiliated with the Trump presidential campaign in 2016, mined the data of more than 50 million Facebook users without their permission. It is impossible even for Facebook to prevent external data profiling firms and even foreign intelligence agencies from mining or even manipulating its 2 billion active monthly users. As Putin’s Kremlin trolls, the Stuxnet virus and Chinese military hackers attest, information warfare is a fact of life in the Digital Age. Facebook is thus the world’s most powerful but also vulnerable social network platform. It is now almost certain that the US Senate will impose tighter standards for digital advertising. Privacy and data protection are bellwether public policy concerns in Trump’s America and the world in 2018.
Facebook has announced it has hired an independent auditor to investigate Cambridge Analytica but I doubt if this is enough to mollify either data privacy activists or enraged lawmakers on Capitol Hill who want public repentence from Zuck and Sheryl Sandberg. In any case, the scandals potential adverse impact on Facebook’s business model is all too real. One, the cost of regulatory compliance, platform surveillance, cyber-security and data protection could pressure operating margins. Two, user growth and engagement metrics could decelerate while this scandal dominates global media. Three, advertising revenue growth could slow, though Facebook offers advertisers the scale and returns on media spend they cannot replicate anywhere else other than Google. As happened with the far more serious data breach at Equifax, it is entirely possible that the public relations storm over Facebook will abate and advertiser revenue growth will remain unscathed.
Headline risks will continue to trigger spasms of selling in Facebook shares, possibly taking it below 150. However, even now, Facebooks valuation multiple has now derated to 23 times earnings. More to the point, Facebook trades at 18.6 times forward GAAP earnings. This is inexperience for the world’s preeminent social media network that has the potential to compound earnings at least 30 per cent per annum in the next three years. Facebook shares will bottom only when Zuckerberg voices a new policy on data privacy that is credible to Wall Street, Congress, corporate clients and his (literally!) billions of active users. There is definitely light at the end of the tunnel for Facebook, the reason I would remain the proverbial “buyer on dips” below 150.
Facebook traded at a 140 per cent valuation premium to the S&P 500 index three years ago. This has fallen to only 28 per cent now even though Facebook’s revenue growth and profit margin puts the index companies to shame. Facebook generated $40 billion in revenue from its 2.1 billion active users in 2017. Yet Instagram alone is projected to generate $10 billion in revenues next year. The value of online brands like WhatsApp, messenger and Oculus has not been remotely monetised. I doubt there will be mass user revolt due to the Cambridge Analytica scandal and the shares will bottom after Zuck testifies to Congress.