The 'Link Tax' In The EU Will Seriously Hurt Google And Facebook's Profit Margins

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Includes: FB, GOOGL, MSFT, PBSFY, SBSNF, TWTR
by: Alexander Johansson
Summary

A new form of tax on links has been passed in Brussels.

The new tax is direcly aimed at major tech platforms such as Google and Facebook.

This is the EU's latest law to force american tech giants pay more tax in the European Union.

I expect profit margins will diminish significantly for both Google and Facebook and Twitter.

This may be the end to old media in the European Union.

Introduction

European union strongly dislike American tech companies, they believe tech firms pay too little tax, plus not paying enough money to European firms when linking or using created content by Europeans. The latest way to deal with this is to impose a "link tax" on big tech firms.

This tax is very likely to pass and become law, with serious implications for internet users in Europe, but also large tech firms with European users.

Profits for mainly Facebook and Google will diminish from Europe and it will be very difficult for them to learn if a European helped create content they link to and therefore should pay money for.

What does it mean?

Only a full vote by the European Parliament stands in the way of the legislation to become law. All signals point to the fact that it will be passed, with huge implications for internet users in the European Union but also for the providers of the internet platforms.

Affected social networking sites:

  1. Facebook (NASDAQ:FB) – 2.23 billion MAUs (Monthly Active Users)
  2. YouTube (NASDAQ:GOOG) – 1.9 billion MAUs
  3. WhatsApp (FB) – 1.5 billion MAUs
  4. Messenger (FB) – 1.3 billion MAUs
  5. WeChat – 1.06 billion MAUs
  6. Instagram (FB) – 1 billion MAUs
  • Two important social media sites left out here it Twitter (NYSE:TWTR) and LinkedIn (NASDAQ:MSFT).
  • Affected search engines include Google and Bing (MSFT).

The two most concerning proposals are article 11 and 13.

Article 11 means that digital platform such as Facebook, Instagram, Twitter, Google and YouTube must pay licenses for linking material the users post. Critics call it "the link tax".

To link is allowed as long as there is no copyrighted material. If there is a headline in the URL that's copyrighted the platform must pay up or remove it.

Article 13 means copyrighted material that platforms haven't payed license for must be taken away from sites or platforms or else they will be fined. A solution for this may be to use filters (perhaps based on Machine Learning) to search, find and remove copyrighted material.

According to documents from the EU council there is a new proposal regarding article 13, where the council suggests that some smaller platforms will receive relief.

This clearly shows that the aim is not to hurt smaller European platforms, but to target the major ones, which are all American.

To be included in the reliefs the company should have at most revenues of 10 million Euro = about 11 million dollars. Have less than 5 million visitors per month and should not have been around for more than three years.

The larger platforms will still be forced to keep filters that stops all copyrighted material if they haven't payed licenses for it.

For example, if a user post a link to a newspaper on Facebook, Facebook is now forced to pay the newspaper for that link.

The voting

438 voted for and 226 against, 39 members abstained. This is a major indication that the EU parliament is very anti American tech firms.

Next comes a negotiation between the parliament and the Commission. If both parties agree the bill will be passed early next year 2020.

The real name for the "link tax" is "Directive on Copyright in the Digital Single Market" and if approved, member states will have two years to introduce the new rules.

European Media Houses

This tax has been lobbied hard by major media houses, but I wonder if they don't shoot themselves in the foot with this bill. This will probably be the end of Google News in the EU as we know it, since they are now required to agree on and pay license to the creator of the news it queries.

Now I believe it is very likely that Google and Facebook and others will create their own media houses and by doing that reform the entire media world.

The European media will loose basically all of their traffic, which is generated from Google and Facebook and this severely threatens the diversity of information we find when we google or surf on Facebook.

I am very bearish about the long term success of European Media Hoses like Modern times group (NYSE:MTG), ProSieben (OTCPK:PBSFY), Schibsted (SCHA.OL), ITV (ITV.L) who is probably still drunk on champagne since the news came out. Now they are forced to either strike deals with Facebook and Google and Microsoft or face competition from them.

Short term this is good news for the troubled media houses, but the long term is another matter (more on why later).

Fake news and smaller (less accountable) media may get an easier path since all others are under license. Meaning more Russian trolls and Russian influence in European news feeds.

This may even be a threat to the freedom of speech, we take for granted in Europe. For example YouTube already uses filters and punishes movies often without good reason. Filters need to improve dramatically and maybe in the future filter optimization will be as important as search engine optimization for websites.

Machine Learning algorithms (AI: s) are very poor at distinguishing between satire and are very poor at separating context from coincidence. If I take a picture looking extremely alike an existing picture in the database, who will have the right to publish their pictures?

The platform with the better, more advance filter is likely to gain an advantage and users will be more inclined to use them instead. As it is now even a sporting event filmed by a user must be stopped from reaching the platform. That is any type of sporting event.

It goes even so far as to state that if your eight year old son is playing football, the arranger of the sport event is the owner of the material and should be compensated if the video is uploaded to the platform.

This will push Facebook and Twitter and the others into the highly competitive sports broadcasting business and perhaps small community sport also, since Facebook users want to publish their experiences on soccer matches both to brag to their friends and also to create likes etc. Little financial gain here for FB since until now users have done that for free, but now FB must find a profitable way to get involved.

This will perhaps be great for the small time soccer club who now can sell deals for their matches for a small fee. But costly and hard to administer for Facebook and Twitter.

News

When links to news no longer can exist in search engines and social media platform's without paying the copyright owner for it, the tech giants will be pushed to create their own news. We have already seen Google taking steps in that direction with their news query Google News. But Google will need to take a big write down on their balance sheet regarding Google news or remake Google news entirely.

How is the algorithm going to know that I am a European citizen writing on an American platform and therefore should be compensated when Google's search engine or the Google news algorithm find and link to me?

Impossible, meaning they can't rely on Google news any more and must therefore create their own news. This will be exciting to see how they are going to implement that in their business model.

Google News

How to deal with the news

Creating your own news and only allowing them to be published on the platform is a winning combination, you will ban or punish all other news sources and force users to use your news engine. You will keep users on your services and linking back and forth between your own Search/Social media engine and your News engine.

If you can get your users to do that they will continue to create new content and work for you and you can track their behavior, pattern and shopping preferences or whatever your users spend money on, even better.

This will spark a race between Google and Facebook but also Twitter and perhaps LinkedIn to create "news engines" to write and create news for us.

They will likely use Machine Learning (NYSE:AI) for this, to make sure they can spit out news faster than what we can imagine and expand the user interaction and sharing on their platform. The platform with the most user friendly news will win the customer/user.

Who will be shown favorably in the news written by algorithms? The ones active and profitable for the news creator? Yes, because it is the duty of management to maximize shareholder profits so it lies in their best interest to write good news about the best users or customers to make them pay even more, and encourage other customers to be more "active" = profitable.

I wonder though how much power and influence users are willing to give to their platforms. They already know every preference, we have, are we really willing to let them track and create our opinions with news also?

Facebook's profits

To keep up with the new regulations major investments need to be taken.

From the Facebooks yearly report 2017 we see that they spend more and more on research and development. In 2015 they spent 4.82 billion, 2016 =5.92 billion, 2017 = 7.75 billion. An increase in core spendings by over 60 % from 2015 to 2017 and I believe this will accelerate.

I think we will see about a 30% increase in research and development in 2018 reaching over 10 billion. And this trend will continue and likely be even higher in 2019 due to the new EU regulations. I think we will see research and development spendings over 14 billion in 2019. This means 4 billion dollars less on the bottom line.

Facebook is not even near such figures in MAU (monthly active users) growth. It makes perfect sense for Facebook to start going into news and sport events and more. Soccer is a big deal in Europe and a popular thing to share on Facebook, will they or Google start bidding against the European firms who broadcast it today? Well winning that bid cost you close to 6 billion dollars for the right to one year of Premier League tv rights in 2019-2022.

Research and development cost was 17% of the total revenue. I expect this to dramatically increase to well over 20% because of the reasons above.

In Q4 Facebook revenues from Europe was 4 115 million dollars for a total of 16 914 million dollars for the whole world. To what extent are they willing to keep those users?

Google's profits

From Google's annual report 2017 we see total revenues of 110 855 million dollars. Advertising revenues were 95 375 million, which is the income from the clicks from users of the search engine. 33% of the revenues comes from the EMEA region = Europe, Middle east and Africa and I think it is fair to claim that the majority of the 33% comes from Europe.

But the most disturbing fact is that how is Google going to know if a European user uses a VPN (a way to go around tracking of the originating computer) or any other way to access the American Google search engine or what if a Europan create content while travelling to USA? How are they going to know that a European didn't help write or filmed the content the search engine found?

I don't see any other way for them than to spend heavily on the filters (or similar tool) I described above to make sure no users see content/information created by a European.

From the annual report 2017:

Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future.

We may be subject to legal liability associated with providing online services or content.

This may be a sign that Google anticipated what was coming and perhaps knows more than most of what countries are planning to do regarding internet links and business related to Google.

Total cost of revenues in millions of dollars:

2015, 28,164. 37.6% as a percentage of revenues

2016, 35,138. 38.9% as a percentage of revenues

2017, 45,583. 41.1% as a percentage of revenues

Clearly rising costs, without any need to follow the new hard rules from the European Union. I expect costs to continue to rise significantly, especially as they need to make deals with pretty much all existing media houses in Europe. Not only costly to start paying them for something they previously got for free (linking to whatever content they liked) but also hard to administer and taking very valuable time from management and key personnel. Plus the hidden cost of needing to focus on building news AI: s and advanced filters (or whatever way they go about it) and not being able to use their best developers for creative projects like they had in the past.

Conclusion

I believe many users, especially tech geeks or freedom lovers will find other ways to share and find information and communicate with each other. And as a matter of fact, there is a whole world out there building infrastructure just for this reason.

The risk is great that users will find other social media platform's or search engines that may not have as advanced technology, but do not impose nor "recommend" commercial or information to its users.

What will happen if more countries follow the European unions example? If this law becomes a success in Europe, what will stop countries in, for example Latin America, the Pacific, Asia and Africa to impose similar laws?

Lots of implications and none of it good for the tech giants described in this article, I see no other way for them to go around this problem other than:1. Stop European users entirely from using their system/platform.2. Make sure all users in all countries follow the "link tax" because they can't track every single European and their whereabouts in the whole world.

This will be costly for all to apply to the new regulations, in the short term the European media houses stand to gain, but in the long term I am not so sure who will gain on this except countries in the EU standing to gain more revenues from taxes.

This will change the market and lessen profits for the giants, new smaller search engines and social media platform may take a larger share of the user base.

Source: https://buffer.com/library/social-media-sites (SA must remove this link before 2020 or start paying if buffer.com is a European company).

Since I am a European citizen, Google must start paying me after 2020 for linking to this article too.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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