Facebook: Felled By The Herd | Tech Industry
Facebook (FB) carved out a bit of history last week in the aftermath of its after-hours second quarter earnings report (25 July). By Friday’s close, markets had scythed an estimated $120 billion in market value, sending the stock plummeting to the threshold of bear territory with a 20% loss from Wednesday’s close. The company’s market losses for the two-day period fell within the range of the total GDP output of Ukraine ($127.1 billion) and Morocco ($119.5 billion) through the end of 2017.
Much of the market’s shoot-first-and-ask-questions-later reaction to the earnings report focused attention on the company’s European operations and the impact of the General Data Protection Regulation (GDPR) that went live on the 25th of May throughout the EU. Under pressure from the GDPR, FB shut down a lucrative advertising tool called Partner’s Categories, which provided targeted advertisements on the company’s platform using third-party data garnered from a variety of sources, including on- and offline purchasing history, in major markets like France, Germany, and Britain. The company plans to shut down the tool globally by the end of September.
FB derives a whopping 99% of its total revenue from third-party advertising on either Facebook or its Instagram platforms. Some of these changes no doubt will impact advertisers’ ability to target particular demographic groups across national European markets over time. Third-party advertisers are constantly assessing the effectiveness of their messaging against available alternatives. To do otherwise would be irresponsible. That this assessment could drive FB shares down 20% in such a short period of time is difficult to fathom. That GDPR could rationally be responsible for the market slide in total is equally hard to swallow. Lacking the financial heft and scope of Facebook and Google, GDPR could very well create a de facto duopoly between Google and Facebook across the European digital advertising space as smaller companies plying targeted advertising platforms withdraw under the onus of heightened compliance costs. The question, then, becomes this: Was the market reaction justified?
While just over 45% of the company’s total revenue of $13.2 billion came from the US and Canada, Europe provided just under 25% of the company’s 2nd quarter earnings at $3.3 billion. Revenue growth in the three months through June came in at just under 42% YOY.
That is more than double the 17% jump in revenue growth YOY for Apple (AAPL) for its fiscal third quarter which ended on the 30th of June. FB earnings of $1.72/share were up 32% YOY, about 52% higher than the 21.3% estimated earnings growth by S&P 500 companies for the second quarter by FactSet. Apple’s earnings rose just over 40% through the period. Trading in Apple shares increased 4% in after-hours trading after Tuesday’s (31 July) earnings report. In comparison, FB fell just short of 20% in the aftermath of its earnings report.
Unfortunately, high-wire companies must be perfectly balanced at all times under the limelight of market scrutiny, and the fact that European revenues grew at 54% in the first quarter was a comparable that would not be lost upon those looking for a reason, any reason, to take profits off the table. Total revenues in the second quarter also rose 42% to $13.2 billion. They rose 49% to just under $12 billion through the end of the first quarter.
There are three measures that both company and industry use to track FB growth: daily active users (DAU), monthly active users (MAU), and an average revenue per user (ARPU). Worldwide DAU came to 1.47 billion through the end of June, up from 1.45 billion in March and up 11% on June 2017. In North America, DAU was largely unchanged QOQ at 185 million but up just over 1% YOY. In Europe, the total for the quarter came to 279 million, down from 1st quarter totals of 282 million, a loss of almost 3 million DAU. The DAU total was up just under 3% YOY. DAU measures for Asian markets came to 546 million, up just over 3%. YOY, the increase was 21%. In the rest of the world, the DAU measure came to 461 million, an increase of just under 2%, while the YOY gain came in at just over 10%.
MAU worldwide came to 2.23 billion, a QOQ growth posting of just under 2%. On a YOY basis, MAU growth was in excess of 11%. MAU in North America remained flat at 241 million QOQ but was up just over 2% YOY. In Europe, MAU hit 376 million, down slightly QOQ from 377 million but was up just over 4% YOY. Asia MAU posted 894 million for the quarter, up just over 2% QOQ and was up 18% YOY. The rest of the world statistic posted 723 million, up just under 3% QOQ and up 11% YOY.
ARPU is perhaps the most important measure of the equation given the number falls directly to the company’s bottom line. ARPU worldwide came to $13.04 billion through the end of the quarter, an 11% increase QOQ and a 42.3% increase YOY. For FB’s biggest market, ARPU in North America came to $6.14 billion, an increase of just over 10% QOQ and an increase of 38% YOY. In Europe, the measure came to $3.25 billion, an increase of 9% QOQ and an increase of 47% YOY. In Asia, ARPU came to $2.3 billion for an increase of 11% QOQ. The increase YOY came to 47%. For the rest of the world, ARPU came to $1.36 billion, an increase of 17% for the quarter over that of first quarter growth. YOY, the increase came to 43%.
Figure 1: Facebook, the S&P 500 against SPDR Technology ETF
For the year, FB (green-red bars, upper frame) stock performance has generally trended to the upside, bumping up against its upper Bollinger line (blue line, upper frame) for much of the May to July period. SPDR Technology ETF (XLK) as a whole (green area, upper frame) performed well above the S&P benchmark (orange line, upper frame) for the period. Facebook as a ratio of the S&P 500 (black line, lower frame) outperformed the benchmark from May through much of July, given its upward slope, also outperforming its 20-day exponential trading average for much of the period (blue line, lower frame in Figure 1, above).
The March slide came as a result of the worldwide controversy produced by the alleged unauthorized use of FB data by the British consulting firm Cambridge Analytica, founded by Robert Mercer, a wealthy Republican donor and Stephen K. Bannon, a former political adviser during the Trump campaign and in the Trump White House. The political dimension of data breach became a watchword for privacy regulation worldwide, spawning Congressional hearings in the US and Parliamentary equivalents in the UK. In Europe GDPR, which is the most comprehensive attempt to date to rein in the use of personal data for commercial purposes, was at the time scheduled to go live on the 25th of May.
GDPR is intended to give consumers greater control of the use of their personal data by technology companies like Google and Facebook who between them control about 73% of all digital advertising in the US and about 42% worldwide. The legal case for privacy regulation, however, rests on the ability to prove harm from data collection and its eventual use in targeted advertising. In theory, giving consumers more control over privacy settings could be effective. In practice, there is a good deal of corroborating behavioral research that points out the fact that most people tend not to change assigned default settings without overwhelming reasons to do so – be it 401(k) withholdings to the information they share online.
That said, FB fell just under 18% in March with the breaking news of the Cambridge Analytica data breach. From a low of $152.22 on the 27th of March to a market high for the year of $217.50 on the 25th of July, Facebook posted market gains of just over 43% as the difficulties of effectively regulating the use of personal data by big data companies were roundly acknowledged by investors worldwide. That all this market growth could change so dramatically by the loss of 3 million DAU and 1 million MAU while revenue per user in the EU under each measure increased for the period is difficult to grasp. GDPR has been on the EU books for a little more than a month. There is little chance that the law has had much of a measurable impact in such a short duration of time. It will take years of data to assess the law’s impact in the data gathering space. By Friday’s market close, however, FB had fallen just short of bear territory.
Historically, investors’ memories, not to mention mindsets, are infamously short-term in nature. I see little underlying reason why FB will remain in the market doldrums for any length of time. FB’s P/E ratio is now at 26.60, almost exactly half that of its big data rival Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) at 52.79. FB shares can reasonably be projected in the neighborhood of $222/share by the end of the year.
Disclosure: I am/we are long FB.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.