Week in Review
In the face of unquestionably strong economic data, global equities declined nearly 5 percent on the week with the S&P 500 falling close to 6 percent. The sharp selloff can be attributed to a confluence of factors, none of which will have any impact on near-term earnings momentum. Facebook shed about $50B of its market capitalization after acknowledging that data on more than 50 million users was acquired and misused by UK-based Cambridge Analytica. A leak of this magnitude stoked fears that tech giants are primed for increased government regulation. At the same time, Washington released additional tariffs on $50B worth of goods imported from China, adding fuel to investor fears that a trade war between the world’s two largest economies is on the horizon. Lastly, the Fed raised rates by 0.25 percent. Although the increase in the Fed Funds rate was widely expected, takeaways were mixed as the Fed’s projection for economic growth increased along with their estimate for rate hikes in 2019. As always, incrementally positive Fed commentary on the economy is interpreted as a hawkish development by the markets.
It has been a bad week for Facebook as a data “breach” highlighted the fact that the company may have less control over the data they collect than they once thought. While we won’t get into the unseemly details of Cambridge Analytica and its business, it is worth noting how they appropriated the data of millions of Facebook users. We will try to attempt to assess the impact this event may have on Facebook as a company and as a stock.
Thousands of apps are developed on the Facebook platform. Prior to 2014, when individuals logged into those apps via Facebook, the app developer could collect their Facebook data. In this instance, it was also collecting data from the “friends” of the app users. This process was allowed under the terms of agreement for Facebook and its users. The app in question was a series of personality quizzes that was in use in 2013-2014. The app would take the answers from the questionnaire, couple them with the individuals’ “likes” and interests from Facebook and then would develop a profile. After all was said and done, the app developer had information on ~50 million people. Shortly thereafter, Facebook tightened their data policies; however, the app developer had already sold the data to Cambridge Analytica. Facebook demanded the data be deleted, and were “told” it was. Lo and behold, it wasn’t.
“We are in the midst of a textbook case study on how not to handle a crisis,” Professor Scott Galloway, NYU Stern School of Business.
When the story broke last week, Facebook senior management gave no answer. The one point they continued to focus on was the data wasn’t “breached” from Facebook. But this has all become semantics. What is being highlighted is the vast amount of data the company gathers, and how that data can be used and manipulated (as is speculated it was used by external forces in the 2016 Presidential election).
Until late this week, Facebook had been MIA regarding a response and still has no solution to the problem of their data policies. This is similar to the issues Google/YouTube went through a year ago about their ad placements and companies pulling ad dollars from the YouTube platform. Google was very proactive in working through those issues, and the incident was short-lived. Over a three-month period, the stock did lag its peers by close to 10 percent.
The question facing Facebook is how management will address the issues publicly, and what the ramifications may be from a regulatory and public relations perspective. CEO Zuckerberg was on CNN this week, but there is still a lot that needs to be done. As investors, our focus is on what, if any, effect will this have on users. If there is a major backlash, will advertisers reduce their ad spending on Facebook? There are a lot of other instances where companies have dealt with credibility/data problems, and investors will be assessing where Facebook will fall. Will it be like Google/YouTube, Wells Fargo or Target? Or will it be more akin to Equifax?
Financially, the company has the potential to grow revenues 30+ percent over the next two years and generate close to $40 billion in free cash. Valuation is attractive, but uncertainty will be an overhang as investors assess the fallout. Their business model, which was once viewed as bullet proof, is now showing kinks.
Finally, one wild card on the future of social media is blockchain. Facebook highlights the concept of a centralized data hub where users do not know where their personal info is going. In a decentralized medium, blockchain, users will be able to track their data. They wouldn’t be able stop others from sharing, but they would be able to see where it’s going.
Takeaways for the Week
- Facebook may prove to be too big, thus attracting government intervention
- Facebook won’t be getting many “likes” over the next several weeks due to this issue regarding user information