Facebook: Where did it go wrong?

It was the forecast of a significant slowing in the second half of the year that caused stocks to tumble

Even after politicians turned on Facebook this year, investors could take comfort from resilient revenues and strong profit margins.

Now they have to consider not only the regulatory threats on the horizon but the more immediate shock of a sharply slower growth rate.

Their reaction was considerable: after missing earnings forecasts, Facebook lost more than $100 billion (€86 billion) in market capitalisation – the biggest one-day value plunge of a listed company in US history.

The social media group had been trading at an all-time high, with 44 out of 52 analysts rating the stock a “buy”, as investors piled into technology stocks and shrugged off the Cambridge Analytica data leak.

But it was not regulatory risk that caused the stock to tumble. It was the forecast of a significant slowing in the second half of the year, making analysts scramble to recast their models for a world in which Facebook's annual revenue growth is in the 20s, not the 40s. David Wehner, chief financial officer, also forecast margins would slip from 44 per cent this quarter to the mid-30s in two years.

While politicians and the press have fallen out of love with Facebook, investors have been bidding it up. The depth of the stock's dive reflects both the concerns over the company's ongoing growth and the extent to which investors had rushed into the club of supercharged stocks that it leads, the so-called Faangs: Facebook, Apple, Amazon, Netflix and Google.

‘Higher standard’

Daniel Ives, an analyst at GBH Insights, said Facebook was held to a "higher standard" among investors. "Their outlook for the second half and for 2019 puts the company firmly in the investor penalty box."

Pinning down the reason for the drop in forecasts was difficult. Neither Facebook nor analysts blamed the scandal surrounding Cambridge Analytica, the research firm that worked for Donald Trump’s presidential election campaign. Mr Wehner said there were “several factors” behind the lowered projections, including currency, new advertising formats and privacy.

The introduction of the General Data Protection Regulation in Europe knocked user growth and engagement. European daily active users fell 3 million in the quarter, a fall of about 1 per cent, and monthly active users were down, but by less. The company said this was consistent with the outlook it had provided the previous quarter and did not say whether it expected the decline to last.But Facebook said GDPR had so far had no significant impact on advertising in Europe, and that the vast majority of users had chosen to opt into data collection.

Privacy concerns

While privacy concerns have awoken politicians and regulators, investors were shocked by the re-emergence of an older concern: that Facebook has reached the limit of how much advertising it can show in its news feed.

Sheryl Sandberg, Facebook chief operating officer, was optimistic that the increasing inventory of Stories, the photo collection format that was borrowed from Snapchat, would be an "important opportunity for growth" because they are full-screen and more "authentic" and "engaging".

Mr Ives said changes to the news feed had exacerbated advertising problems. “Engagement continues to be an issue on the Facebook platform. Engagement drives advertising.”

But he has maintained a “buy” rating on the stock because he believes Facebook’s forecast is proof of a “six- to nine-month transition period”.

Brian Wieser, an analyst at Pivotal Research, has a "sell" rating on the stock, however. He argued that Facebook was hitting the limits of its growth in the digital advertising market, which has rapidly won budgets from print and other media – but not yet television.

– Copyright The Financial Times Limited 2018