The Facebook Hearings Prove Regulation Is Not A Sure Thing

About: Facebook (FB)
by: Joe Albano

Bears see regulation as imminent and will be the downfall for Facebook's financials.

The reality is this isn't the actual path forward and Congress shows no unanimity toward regulation.

This incident will move on and fade into the memory of Congress and users, allowing Facebook shares to return to its trend.

Many Facebook (FB) bears in the last handful of weeks have clamored the company's financials are headed down from here forward because of regulation, among other things. The argument in essence says regulation will hurt Facebook's top and bottom line while all of the changes coming to Facebook's platform and human resource allocation toward security will hamper growth heavily.

There's a few things to get straight in this discussion because much of what the bear side is saying are things which are over-exaggerated, wrongfully considered a sure thing, or is already known to the market.

(Source: The Ray Tribune)

Let's start with the US government and regulation therein. Considering Facebook derives just shy of 50% of its revenue in the US and Canada while its revenue per user there is three times that of Europe, it would appear regulation in the US would have the largest impact on Facebook's top and bottom line.

So with the US as the biggest risk to the company's growth, it's fitting to understand the probability of regulation here at home. After watching three of the five hours of the Senate hearing and all five hours of the House hearing, there is a clear showing from representatives that regulation against Facebook or other internet companies is not a unanimous sentiment.

Furthermore, the calls of regulation came largely from Democrats who do not have a majority in either the Senate or the House. Therefore, passing laws leading to regulation is not a foregone conclusion as it would require full Republican support, and still leaves room for defectors of the party to spoil the majority vote.

So if regulation cannot be passed with today's 115th Congress when is it possible?

If in the 2018 mid-term elections, Democrats manage to win 25 seats in the House and 4 seats in the Senate, they can theoretically push through what they wish. An election outcome such as this is very much a possibility but there is more to this than just winning seats (and not having any party defectors in the case of a vote).

It's clear in this day and age there are many competing priorities and many things fall to the wayside. Right now, this consumer privacy appears to be the priority, but in January of next year (when the 116th Congress is sworn in) will it be - regardless of election outcomes?

Very unlikely.

How do I come to this conclusion? It's rather simple. Gun control - which is much more serious than Facebook content in the hands of a third party - has no pending measures or proposals as of today, especially those with real odds of being passed. In fact, there's nothing specifically on the table about gun bans or restrictive gun laws - and we're only two months removed from the latest calls for new laws. The only way this privacy issue becomes a priority again is if Facebook has new information about a post-2015 issue down the road.

Additionally, a majority of Congress is highly misinformed and technologically inept. Some Senators and Representative did indeed have a decent grasp on the issues but an overwhelming majority appeared to not even understand the facts of the situation with Cambridge Analytica or Facebook itself. This is clear by Mark Zuckerberg's need to repeat several points over and over again.

Many had the impression Facebook's model is to actually sell data - which those who understand the business model know they simply reach users with the data they have without sharing the actual data. For many in Congress this was a hard concept to grasp. But, this same circle of folks are now supposed to agree on one piece of legislation to pass?

All That Expensive?

Now regulation aside, bears still consider this situation to be expensive as Facebook must do a lot more to get control over its content. But this point isn't anything new. If we go back to November of last year to FB's third quarter conference call, you might remember Zuckerberg mentioning this:

We already have about 10,000 people working on safety and security, and we're planning to double that to 20,000 in the next year to better enforce our community standards and review ads. In many places, we're doubling or more our engineering efforts focused on security. And we're also building new AI to detect bad content and bad actors, just like we've done with terrorist propaganda.

This narrative hasn't changed as this same 20,000 figure was repeated these last two days by Zuckerberg ad nauseam. So when Zuckerberg mentions 20,000 contractors working on security and platform compliance, it's nothing the market hasn't already heard and priced into the stock.

In other words, this is rehashed information because the company already planned on this change. And even if you want to make a big deal about it again today, I decided to do some back of the envelope numbers to get a ballpark figure about what this would cost them.

Since these employees are mainly contractors and the work they do is entirely online, about 99% of them will be remote jobs (work from home), so the company won't be using its leased spaces. If we assume these additional 10,000 employees who are doing review work get paid $15 an hour and Facebook is hiring them through a third party, FB could be paying $20 an hour for these contractors. If each contractor works 40 hours a week, 52 weeks a year, then the man hours come out to 20.8M.

Multiply this by $20 and we get $416M. Keep in mind this is for the entire year which means this is 1% of 2017's revenue and 2.5% of the year's net income. All while the company grew revenues at 47% and net income at 56%. And since these 20,000 employees are fixed costs, the more Facebook brings in the less this effort effects the bottom line.

The Real Bottom Line

All things considered, not only has this security hiring been baked in for two quarters, it appears regulation which is supposedly set to hamper Facebook's revenue or profits is likely not to happen in the US. Even some Congress members made mention that their constituents weren't blowing up their phones or breaking down their door over this issue. This not only means #DeleteFacebook likely had very little traction but corporate virtue signaling has no reason to continue and these representatives have little reason to push forward regulation.

It's clear the market is realizing this as the stock has recovered nearly 12% since the recent bottom following the news. The Congressional hearings were clearly nothing to worry about as many representatives only showed their teeth to signal they did something, while others confidently came out and said the worse thing we can do is regulate and overreact. These hearings proved there is absolutely no unanimity in regulation - not to mention the party who does favor regulation is not in the majority.

As I said three weeks ago, this is all politics and the actual financial impact to Facebook is little to nothing. Soon the advertisers who paused spending will resume if they haven't already, the few who deleted their Facebook accounts will resolve to one of Facebook's other platforms - if not return to Facebook outright - and Facebook will continue to implement the security tools and contractors it already had budgeted for.

Facebook recovers from this.

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Disclosure: I am/we are long FB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.