Zuckerberg Got Grilled Before Congress, But What's The Valuation Impact?

Summary

• Zuckerberg faced Congress in two days of wide-ranging questioning on Facebook's history, business practices, the potential regulatory framework to implement on it.
• The Cambridge Analytica's risks to Facebook are real, but it is increasingly seeming like the manifestations of the fallout may not be too impactful on the revenue/growth trajectory.
• The implementation of advertising disclosures and data use consent seem the most predictable results from the United States. Such measures are not likely to damage user activity or revenue significantly.
• The fallout in terms of user activity will need to be watched closely, particularly in Facebook's upcoming Q1 2018 earnings. Until then, past inertia is likely to predict future platform stickiness.
• Europe remains unpredictable however, with regulators far more unfriendly in the past to Facebook and very concerned about user privacy. The fallout there needs to be watched closely.

While Zuckerberg's testimony provided a lot of media theatrics and the regulatory risks are real, the likely manifestations of Facebook's (FB) political risks at the moment are unlikely to be so dramatic as to shift its growth trajectory significantly.

"The Social Network" Part Two

This past week Mark Zuckerberg testified personally for the first time before a joint committee session of the United States Senate on Tuesday and the House of Representatives on Wednesday.

Facebook is facing regulatory concerns from across the world, including the implementation in May of the impending General Data Protection Regulation for data use consent in Europe (whose origin was well before the Camrbridge Analytica scandal).

Even Facebook's fellow tech giants have been throwing it under the bus, with Apple (AAPL) taking this opportunity to allege that its data protection practices are far more pro-user than Facebook's.

The U.S. political risk remains the most important however because that is where the bulk of Facebook's advertising currently comes from, where it's the most profitable, where it's publicly traded, and where its headquarters and personal eco-system are based.

(Source: Facebook Q4 2017 Earnings)

While the Cambridge Analytica events were the catalyst for the hearings and undoubtedly are a significant scandal on their own, the hearings clearly were a vent for many long built-up policymaker and public concerns over Facebook's, and other social media and Internet services companies, various practices.

Lawmakers largely abandoned focusing on just the Cambridge Analytica events and questioned Facebook on everything from protecting the platform against bots and misinformation to viewpoint censorship, from usage of user data to whether users had proper knowledge of the data they were providing, from political influence by Facebook itself to even anti-trust monopoly and competition concerns.

In terms of market reaction, Facebook stock gained heavily in the midst of the initial hearings on Tuesday afternoon, rising about 5%. On Wednesday the stock rallied too during the hearings, but then gave away much of its gains as the trading day closed.

FB Price data by YCharts

Facebook stock is now well off its late-March lows in the wake of the original regulatory, competitor, and user worries in the wake of the Cambridge Analytica scandal.

FB data by YCharts

The scandal's turbulence even caused Facebook's trailing P/E multiple to contract to the lowest in the company's public history, hitting a lot of just above 26 at its lowest point.

FB PE Ratio (TTM) data by YCharts

Undoubtedly there still remain real business and valuation, and therefore investor, worries for Facebook from the scandal's fallout and the subsequent policymaker, user, and business reactions. At the moment however it looks like the most extreme reactions, such as a mass-abandonment of Facebook's platform by users or policymakers engaging in tectonic-shifting acts such as anti-monopoly action or data use restrictions, do not appear very likely, at least from the United States.

Rather, the more likely spending of legislative energy and public attention may result in the passage of the "Honest Ads" Act, which both Facebook and Twitter (TWTR) have endorsed and support, which would require disclosures for political ads on their platforms just like political ads are required to do so when advertising on radio or television.

While such a disclosure may deter the most shady of political groups or nefarious actors from advertising on Facebook, the revenue impact looks minimal and may in fact have the counter-impact of raising user trust in political ads, and therefore political ad effectiveness, and therefore political advertiser interest.

Other potentially likely regulations include a data use consent requirement, such as Europe's GDPR, which requires affirmative user consent and ability to manage their data that is collected. While some users may not consent once they understand the vastness of the information Facebook collects and stores on them, Facebook's past inertia and stickiness means that the idea of users fleeing the platform en masse should be doubted until quarterly user activity numbers are released.

Undoubtedly when Facebook releases its Q1 2018 earnings on April 25 we will have at least some clear data-based picture of how user count and activity, as well as advertiser spending, has been affected by the scandal. Until then, past results likely predict future results.

Across The Pond In Europe...

In contrast, Europe, which has in the past adopted a much harsher tone towards technology companies and their use of data, remains unpredictable in how fiercely exactly they will act and there remain significant anti-monopoly political risk concerns there.

Europe has in the past been much harsher with implementing actual anti-monopoly monetary sanctions on companies such as Google (GOOG) (GOOGL) and the discourse there takes a far more serious tone towards data privacy.

The talk in the United States of the Federal Trade Commission's potential penalty for Facebook's alleged violation of its 2011 consent decree with the FTC on user privacy resulting in the maximum $40,000 fine per violation is unlikely to manifest in the full fine.

With an estimated 50 million users affected by the Cambridge Analytica scandal, that would thereby be a maximum "on the books" FTC fine of over $2 trillion, obviously wiping out Facebook. U.S. regulators are almost certainly unlikely to engage in such an action, and even if they were to engage in an especially harsh sanction the resulting regulatory settlement or court challenge likely would diminish it significantly. It remains possible some FTC fine will result, but it will unlikely be so harsh as the potential maximum.

In Europe however such mega-fines have been actively implemented, such as Google's $2.7 billion anti-trust fine last year. With Europe still about a quarter of Facebook's revenue, that situation will be worth watching far more closely.

Conclusion

It is clear that Facebook is undergoing perhaps the greatest challenge to the platform in some time from multiple fronts, ranging from user outrage, advertiser questioning, competitor action, and policymaker fury.

While it appears likely some forms of regulation will come of this that may better protect user data as well as disclosure and transparency on the platform, they at the moment, at least from the United States, do not appear likely to affect revenue and thereby growth trajectory.

Analyst’s Disclosure: I am/we are long FDN. 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.