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John Kinsellagh
John Kinsellagh
Articles (203) 

Facebook's Credibility Gap Tanks Share Price

Analysts were duped by rosy revenue projections that downplayed regulatory impact on business model

July 26, 2018 | About:

Facebook (NASDAQ:FB) shares plummeted 17% on Wednesday's news that the company had missed its user growth and revenue targets. CEO Mark Zuckerberg also announced that he expects lower revenue growth to continue for the immediate future.

The company expects that revenue growth will drop precipitously this quarter and the next, along with its long-running, sky-high operating margins.

Approximately $2 billion was slashed from revenue projections for this year, which are now expected to be only $55 billion; the following year will see even more severe reductions with some analysts reducing their original estimates by $5 billion or more.

It was only a question of time before the stock price reflected the reality that impending regulations would have a detrimental effect on Facebook’s bottom line. What happened Wednesday, was the fallout from the data breach scandals finally caught up with the company’s actual and projected revenue.

Facebook’s operating margins could never stay at 49% indefinitely. Those enviable numbers were achieved in an environment of complete laissez faire and a total lack of even the most minimal regulations, the costs of which every single S&P 500 company has borne for decades. Indeed, Chief Financial Officer David Wehner expects margins to drop to the mid-30’s over the next several years.

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Analysts were caught off guard, in part, due to the blithe and reckless indifference exhibited by Facebook’s senior managers concerning the privacy scandal’s repercussions for profit margins.

The astonishing public and highly misleading statements made by Zuckerberg and Chief Operating Officer Sheryl Sandberg, along with other senior managers for the past several months, clearly indicate there is a serious disconnect within the company between the perceptions and misrepresentations of its senior executives related to reduced profits and the company’s actual revenue figures. Remarkably, an unrepentant Sandberg and Zuckerberg continued to maintain this façade even during Wednesday’s conference call, until Wehner dropped bombshell after bombshell about the inevitability of slower revenue growth, leaving many investors stupefied.

The casualty from Wednesday’s conference call was the credibility of Sandberg and Zuckerberg. Who is now going to accept future statements they make at face value?

The enormity of the senior executives' stupidity with regards to misrepresentations made concerning the effect privacy abuses would have on revenue was temporarily masked by analysts continued ebullience for the social media giant. That mask was cast off following the almost 20% drop on Wednesday.

One thing is certain: class-action lawyers are preparing complaints that will be filed shortly in federal district court alleging violations of the anti-fraud provisions of the securities laws. Any damages that may be awarded won’t put the company out of business, but the potential harm could have been easily mitigated had the company been more circumspect about its public statements concerning ramifications of user privacy abuses on its revenue.

Far too many security analysts discounted the effect the privacy scandal and impending regulations would have on the price of the stock. Although Facebook is only selling at 11 times forward earnings, Pollyannaish projections were made that could not comport with financial reality. The company finally acknowledged it would see a hit to revenue growth, owing to changes to its products that aim to enhance privacy would have on its business model.

Many analysts imprudently focused exclusively on the ability of Facebook’s advertising platforms to continue generating revenue due to advertisers having few alternatives to target specific markets accurately.

Current growth in advertising revenue, however, is somewhat immaterial if the regulations at some point will lower the number of user profiles that will be available and the types of information that can be extracted. The company has not yet been fully impacted by the European General Data Protection Regulations, but continuing regulatory scrutiny in the U.S. will ultimately lead to similar regulations that will further hamper its ability to sustain operating margins that captivate the Street.

For a taste of the future, investors can look to the recently enacted California privacy act, which will constrain the company’s ability to collect, use and harvest data for its exclusive use without users' knowledge or consent The market never priced the negative effect these regulations and statutes would have on revenue growth.

Wednesday’s conference call shook many analysts from their Facebook-will-grow-forever slumber.

Going forward, many investors will now be more judicious in their expectations concerning the company’s earnings per share growth trajectory.

Disclosure: I have no positions in any of the securities referenced in this article.

About the author:

John Kinsellagh
John Kinsellagh is a financial writer, former financial advisor and attorney, with over twenty-years experience in civil litigation and securities law. He completed the Boston Security Analysts Society course on Investment Analysis and Portfolio Management.

He has served as an arbitrator for FINRA for over 25 years resolving disputes within the financial services industry. He writes primarily on financial markets, legal and regulatory issues that impact the investment community, and personal finance.

He is the author of "Election 2016" and "Mainstream Media- Democratic Party-Complex," both available on Amazon.com

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MasonQDT
MasonQDT premium member - 2 years ago

Price drops...I buy more...;)

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