Facebook Inc. (FB, Financial) is once again facing the wrath of regulators. On Dec. 10, the Federal Trade Commission announced the filing of several lawsuits against the company, primarily attacking its dominant position in the social media industry. The main argument laid out by the FTC is the monopolistic power displayed by Facebook over its peers in the recent past. Commenting on the now-active lawsuits, New York State Attorney General Letitia James said:
"We are taking action to stand up for the millions of consumers and many small businesses that have been harmed by Facebook's illegal behavior."
On the surface, Facebook seems to be in trouble, so investors might think about taking precautionary measures until there is more clarity regarding these regulatory issues. On the contrary, a careful analysis of historical events and the company's financial position leads to the conclusion that the future is promising for Facebook and these lawsuits are likely to turn out to be a minor challenge.
The FTC complaint
The FTC believes Facebook has used its market-leading position to gobble up competitors over the last several years, which has effectively created a monopoly in the social media industry. The commission argues the company has used this power to crush competition without focusing on improving its products and services. Director of the FTC's Bureau of Competition Ian Conner said:
"Personal and social networking is central to the lives of millions of Americans. Facebook's actions to entrench and maintain its monopoly deny consumers the benefits of competition. Our aim is to roll back Facebook's anticompetitive conduct and restore competition so that innovation and free competition can thrive."
To achieve the objectives highlighted by the FTC, the lawsuits suggest several actions:
- Divest Instagram and WhatsApp, two companies that were acquired in multibillion-dollar deals.
- Prohibit Facebook from imposing anticompetitive conditions on software developers.
- Require the company to obtain the approval of regulators before finalizing future deals.
The case against Facebook is centered around the massive size and scale of the company, and there's reason to believe these litigation issues will not prevent the company from delivering lucrative returns to long-term investors.
Learning from history
2018 was a year in which Facebook came under massive regulatory pressure. The share price tumbled from over $200 to below $150 within a few weeks as several security breaches came to light, indicating that users' confidential data was accessed by unauthorized third parties. This led to the filing of several lawsuits against Facebook demanding billions of dollars in compensation, and the company ended up paying a record $5 billion fine in 2019 for failing to preserve the data of its users.
This, however, did not stop the stock from climbing to new highs as investors appreciated the number of measures taken by the company to ensure such a breach of confidentiality will not occur in the future. Facebook pledged to double the staff in its cybersecurity department and invested millions of dollars in developing artificial intelligence-driven solutions to identify threats. All these actions, coupled with the growth in earnings, has resulted in Facebook shares appreciating by as much as 100% from the lows seen in mid-2018. The social media giant was proven to be too big to fail, and things could turn out to be similar this time around as well.
Two prominent Wall Street firms covering Facebook believe the antitrust allegations will have little to no impact on future earnings and market performance. Wedbush analyst Michael Pachter wrote:
"There is certainly merit to the FTC's allegations that Facebook has strengthened its competitive position through the acquisition of WhatsApp and Instagram. However, we are skeptical that the FTC will prevail as it would be hard to prove that Facebook precluded competition. We doubt a Federal court will compel a divestiture or that a divided Congress will pass a law that forces such a result."
KeyBanc analysts hold the same opinion. In a research note to clients, it wrote:
"Consumers do not appear to be harmed by Facebook's acquisitions, and we fail to see why a multi-year breakup process should take place. The lawsuits will likely be resolved with another fine and additional scrutiny on future M&A."
A multibillion-dollar fine will not be welcomed by investors, but such a penalty is unlikely to meaningfully deter long-term shareholders from betting on the company's ability to deliver stellar returns.
The outlook is promising
There are two primary reasons for expecting alpha returns from Facebook.
First, the company has built an economic moat as a result of the network effect, a phenomenon whereby increased numbers of people using a platform inflates the overall value of the product. A consumer has little incentive to maintain a social media profile outside of Facebook as the absolute majority of internet users are active on this platform. The chart below illustrates the number of monthly active users of the most popular social media platforms.
Source: Company filings.
Both advertisers and users will likely stick with Facebook for an extended period due to its massive scale, which will help investors book handsome returns in the long run.
Second, both WhatsApp and Instagram are under-monetized, but these two platforms have the firepower to help Facebook grow by double digits. The company is moving swiftly to popularize WhatsApp Pay, a merchant solution for small business owners. The product is currently live in India through WhatsApp Business accounts, but the goal is to build this payment solution into something similar to WeChat in China. The growth of the number of influencers on several topics, on the other hand, provides the company with an opportunity to market its Instagram Shopping products, and Facebook has already taken a few measures to monetize the photo-sharing app.
One other factor that will help the company's financial performance is the expected revival of the global economy in 2021. Advertising industry revenues are closely tied to the marketing budgets of global companies, so the challenging business conditions created by the Covid-19 pandemic caused these companies to slash their advertising expenditures earlier this year. As illustrated below, ad dollars came back to the table as soon as the recession fears subsided during the aftermath of the global financial crisis in 2008, so a similar trend could emerge when global business activities increase in the coming year.
Source: Eurasian Economists Association
The outlook, therefore, is promising for Facebook if the company can successfully thwart the threat of regulators.
Takeaway
Facebook has once again found itself on the wrong side of regulatory issues. The company, however, is likely to move past these issues and get back on track, which is exactly what it has done in the past. The macroeconomic outlook is positive and the company is well positioned to deliver double-digit earnings growth in the coming years by monetizing WhatsApp and Instagram. If the stock tumbles as a result of the regulatory scrutiny, growth investors should ideally bank on the opportunity.
Disclosure: The author owns shares of Facebook.
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