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Opinion: “Just a flesh wound,” or why Facebook’s very bad week is being overplayed
by Olivier Blanchard | July 27, 2018
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Filed under: Opinion

If you spotted the Monty Python reference in the headline, points to you. If you didn’t, a whole new universe of cultural references is just a click away.

What happened:

All right. Let’s talk about Facebook for a few minutes. In case you missed it, Facebook’s Q2 2008  earnings call didn’t go very well. Among other red flags, Facebook announced that it had fallen short of investor expectations with regard to active user size. (This is a pretty important metric for social media companies since they reflect audience growth relative to potential ad sales.) Seeing what Facebook’s active user numbers look like on a timeline helps explain why investors appear to be losing faith (and running out of patience) with Facebook.

And while not catching the eye of many investors and journalists, the fact that Facebook has been struggling to grow (or even to hold on to) its younger audience demos, does spell trouble for Facebook in the long run. (The average Facebook user’s age is creeping upward, which isn’t exactly a good sign for advertisers.) That reminds me that we should have a discussion about Snapchat and Instagram soon… But I digress.

In addition to the active user numbers disappointing investors, revenue growth also fell short of analyst expectations, but only barely: The company hit $13.2 billion in Q2 instead of $13.3 billion. All of this, of course, on the tail of a year and half of data privacy scandals, election-tampering-related bad press, poorly worded statements from top executives, and questionable policies regarding what does and doesn’t constitute hate speech on the platform. In other words, Facebook didn’t go into this week’s call with a whole lot of good will in the bank. Investors understand that leadership matters, and no matter how good the numbers are, and how much potential a company has, they are keen when it comes to spotting weaknesses and red flags. I would argue that good analysts and investors are better at smelling blood from miles away than Great White sharks.

And just like sharks, investors can overreact to the scent of blood in the water, and go into a frenzy. Especially when there is suddenly a lot of blood in the water. Per Bloomberg:

“The company told Wall Street the numbers won’t get any better this year. Chief Financial Officer David Wehner said revenue growth rates would decline in the third and fourth quarters. Analysts who follow Facebook were blindsided, asking frequently on a conference call with executives for more information on exactly how the company’s financial future had changed so dramatically.”

Naturally, Facebook’s stock tanked. Again, per Bloomberg:

“The company’s shares fell the most in its history as a public company, wiping out more than $120 billion in market value. It marks the largest ever loss of value in one day for a U.S. traded company.”

As I write this article, this is how Facebook is currently trading. Who knows where Facebook’s stock will be when you get around to reading this.

Why it happened (and why it shouldn’t have):

I am a bit perplexed that any serious analyst would be blindsided by these news. The downward trend of active users is nothing new. (See the first graph in this post.) Facebook hemorrhaging young users is also nothing new. Facebook’s PR troubles, which involved Marc Zuckerberg having to go before Congress to testify about his company’s plan to preserve data privacy and combat election-meddling through his platform wasn’t exactly a secret. Article after article about users leaving the platform (out of boredom, privacy concerns following the Cambridge Analytica scandal, and emotional exhaustion due to the increasingly contentious nature of user interactions on Facebook) should have come across their desks. Any attentive, competent analyst should have seen this coming.

Moreover, Facebook’s financials were far from catastrophic: Facebook’s Q2 net income was up 31% YoY. That isn’t exactly bad news, especially for a company whose user growth appears to be flatlining. Facebook’s financials, given the short-term challenges that the company faces, not the least of which is the EU’s new data privacy rules, which Facebook may need time to adjust to, should have energized investors. In my view, they reflect the company’s ability to print money no matter how rocky the road gets. And as long as a company can grow its revenues the way Facebook does, it has the ability to buy itself the time it needs to adapt, change, and evolve as needed. Say what you will about Facebook, hate it or love it, it still appears to be one of the most resilient and adaptable companies in the world. This week’s call should have proved that.

From where I sit, many of my fellow analysts screwed up. Either their models were flawed, or they weren’t prioritizing (and deprioritizing) the relevant inputs. Maybe their instincts were also wrong. (Analysts can often be too clinically removed from the companies they observe to get a real feel for what is really happening outside of a very narrow frame of reference.) There’s an art to this. It isn’t just about data and tables.  Honestly, I can’t really figure out why so many of them could have been so wrong. But the problem now isn’t just that they failed to understand what Facebook was doing, or how to properly interpret Facebook’s strategy ahead of this week’s call. The problem is that, by setting the wrong expectations for investors, many analysts turned a mixed bag of good financial news and unsurprisingly slumping user growth numbers into a maelstrom of panic. And in this regard, the blame also falls on Facebook execs, who should have done a better job (and a more proactive one) of managing expectations. That failure, not Facebook’s numbers, caused this week’s debacle. All of it could have been avoided.

Why the market was so completely wrong about this one:

In the interest of resetting expectations, let’s take a deep breath and look at Facebook’s viability again:

  1. Facebook’s active user base cannot keep growing forever. At some point, its user growth will be zero, and that’s fine. Why? Because Facebook is unlikely to run out of ways of generating revenue from its 2.5 billion users across all of its platforms. There are other ways for Facebook to grow than through net new active users. Stop looking to active user growth as a primary metric. It isn’t 2012 anymore. We’re past that now.
  2. There is currently no real alternative to Facebook. Sure, the kids love Snapchat, Twitter is still out there, and Instagram (Facebook) is a lot less stressful. But there is no “Facebook killer.” Even with privacy concerns, harassment from trolls, fake news, and an endless list of user complaints, there is no sign of a mass exodus. There is no competition for Facebook. Not really. Users aren’t going anywhere.
  3. The value of Facebook’s data is still what it was a year ago, and tighter privacy laws won’t effectively change that. Also note that while younger users aren’t necessarily on Facebook, Facebook also owns Instagram and WhatsApp. In other words, “Facebook” isn’t Facebook’s only source of consumer data.
  4. Facebook has a lot more irons in the fire than just its nameplate social network. The company will look very different in five years than it does now. Much like Amazon and Google, Facebook is evolving. Pay attention to which technologies and market plays Facebook is investing in. That’s where the future of Facebook is, not in active user growth.
  5. Facebook knows how to monetize its users, and it will only get better at it in the next few years. Focus on that.
  6. Back on 27 March of this year (a mere 4 months ago), Facebook was being traded at $152 a share. Despite what happened to Facebook’s stock price in the last few days, $176 is still better than where Facebook was just 4 months ago. Moreover, Facebook’s stock today (as I write this post) is being traded at roughly the same price as it was on May 4th of this year (less than three months ago). Perspective: All of the gains wiped out this week were only two months old.

In other words, Facebook has challenges, like any other company, but, in my view, this week’s market reaction to its Q2 numbers was irrational and ill-informed. My only question now is this: Will this stock deflation serve as a true market correction (assuming that Facebook’s stock value may have been overinflated), or was this just a bump in the road for a company whose stock price grew from $38 in 2013 to roughly $200 in 2018? Look at that growth. Now map it against the user growth graphic at the top of this article. That should help answer that question.

My guess is that, love it or hate it, Facebook still has immense (and vastly untapped) market potential. Facebook will bounce back. I see no reason why it wouldn’t. In the meantime, analysts and Facebook executives need to start getting their ducks in a row when it comes to managing expectations in the future. This week’s debacle shouldn’t have happened, and should never be allowed to happen again.

 

Cheers.

Disclaimer: This article is for informational purposes only and in no way should be taken as investment advice.

About the Author

Olivier Blanchard has extensive experience managing product innovation, technology adoption, digital integration, and change management for industry leaders in the B2B, B2C, B2G sectors, and the IT channel. His passion is helping decision-makers and their organizations understand the many risks and opportunities of technology-driven disruption, and leverage innovation to build stronger, better, more competitive companies.  Read Full Bio.