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When Is Regulation Good For A Company's/Sector's Valuation?

|About: Facebook (FB), FDN, TWTR
Summary

Though it may initially seem that all regulation is either negative or unimpactful for a company, there are times when regulation can in fact be a boost to company earnings.

I look at the "Honest Ads Act" situation, which would require funding disclosures on certain online political ads, in the United States as an example.

Supported nominally by Facebook and Twitter, it initially seems strange they would want regulation on themselves - but it in fact, as I describe, actually makes a lot of sense.

In looking at regulation one therefore can't just look at the policy as an isolated action but needs to look at the entire chain reaction and eco-system it operates in.

I was recently thinking about the variety of tech regulations that have been considered and/or implemented over this past year. In particular, I was thinking about how Facebook (FB) and Twitter (TWTR) back several months ago announced that they were supporting, at least nominally, regulation in the United States on themselves in the form of the "Honest Ads Act."

It seems initially strange that any company would support government restriction of their activities. Furthermore, it seems natural that any government restriction would hurt the regulated company's and sector's earning power. Yet upon deeper reflection, this may not always be the case.

Look at the Honest Ads Act in particular for example. Currently political ads in print and on radio and television are required to disclose who paid for them. In contrast, online ads don't. The Honest Ads Act would legally require them to now do so.

(Source: Bloomberg)

Such regulation may be seen as beneficial to companies for two reasons:

1. It Solves A Collective Action Problem

Often in business, policy, or other situations there is a "Nash Equilibrium" problem, whereby each individual actor acting in their own self-interest results in a situation where each individual is worse off than if they had cooperated as a whole in a certain way.

In business, this can be when each company acts in a certain way to make efficiencies or gain clients. However there may be a better way for the company to act for itself or the entire sector, but that it cannot pursue because to do so would put it at significant risk or disadvantage.

In this ads situation for example, it could be that if an Internet services company (FDN) were to unilaterally require disclosures that many advertisers would flee to other platforms. Despite it being of benefit to all online advertising companies to have disclosures, as that would increase user trust in the platform and reduce nefarious activities, it doesn't happen.

The regulation raises the minimum standard such that no company has to risk it themselves to pursue such an action.

(Figure: Pro-Honest Ads Act image from Issue One, a non-partisan non-profit, Source: Issue One)

2. It Puts Off Other Regulation

Public opinion and policy work mostly as sudden buildups of energy that dissipate, whereupon the issue is discarded until the right "storm" brews again.

If a regulation or bill were to be passed on a subject matter, it is very unlikely another policy action addressing the issue would be enacted until another new situation arises to create the public will for it.

In looking at this case, the "Honest Ads Act" is a relatively minor bill that barely affects the companies' fundamental data collection and usage at all. It is even far less impactful than Europe's GDPR, already considered still a generally light regulation.

Given the much more draconian regulations that have been considered over the past few months, ranging from data use restrictions to anti-trust action, only political ad disclosures as the result of all of it would be seen as a major win for technology companies given the alternatives.

(Figure: Pro-Honest Ads Act image from Issue One, a non-partisan non-profit, Source: Issue One)

Conclusion

Though counter-intuitive, it is clear that in many cases an enacted regulation does not only have a "negative" or "none" impact dichotomy. Rather, it can at times be a boost to a company's earnings trajectory or an entire sector.

At my Marketplace service Tech Investment Insights I look closely at technology companies and the portfolio strategies to design the ideal risk-reward allocations from them.

Examining all factors affecting a company's investment profile including business factors, sector developments, competition, and policy/regulations/legal impact, as well as using a ratings system to create balanced portfolios depending on your goals, I hope you will try it out.

Disclosure: I am/we are long FDN.