October 30, 2018 / 10:07 PM / 18 days ago

Breakingviews - Facebook heads into an earnings pincer movement

The Facebook application is seen on a phone screen August 3, 2017. REUTERS/Thomas White - RC13B0FC4740

NEW YORK (Reuters Breakingviews) - Facebook is heading into an earnings pincer movement. Sales growth at the $410 billion social-media network slowed in the third quarter, the company said on Tuesday. Combating that and other problems means spending more, hitting both top and bottom lines. That may force Chief Executive Mark Zuckerberg to take rash countermeasures.

Executives warned in July that the pace of spending from advertisers, which makes up nearly all its revenue, would decelerate during the second half of the year. Its stock has plummeted nearly 35 percent since then, making it the worst performer of its major U.S. tech peers Amazon, Apple, Netflix and Alphabet.

So it should be no surprise that revenue increased 33 percent last quarter, compared with 47 percent in the same period last year.

Shareholders may be stuck with the more pedestrian rate of growth. Facebook’s recklessness with customer data coupled with Kremlin-backed meddling in the 2016 U.S. elections are two massive challenges. Many people also partly blame Facebook for the highly charged political climate and unsettling divisiveness coursing through America and beyond.

Zuckerberg has pledged to spend to clean up the toxic newsfeed while fighting regulators eager to rein in Facebook’s use of members’ information. The likely result is a fall in users, as Twitter is experiencing as it kicks off bots and other accounts. The number of daily active users was flat in North America and fell in Europe compared to the prior quarter. Fewer people using the network reduces Facebook’s pricing power with advertisers. That’s already flowing through to the operating margin which declined to 42 percent from 50 percent in the third quarter last year.

Assume it gets ugly for Facebook, with the margin slumping to just 20 percent by 2020. Meanwhile revenue growth decelerates to 10 percent from a projected 36 percent for 2018. That would shrink Facebook’s market value to some $160 billion, based on the current multiple of 15 times 2020 earnings estimates.

A company’s results don’t have to get that bad for executives to start looking for an escape plan. Often, that includes going shopping. Zuckerberg’s eye for a deal has so far been fairly sharp; snapping up Instagram for $1 billion was a shrewd move. But desperation can blur vision and lead to ill-advised M&A. That can end up as friendly fire.

Breakingviews

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