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Regulators Will Impact Facebook Earnings Multiple Negatively

|Includes: Facebook (FB)
Summary

Facebook's portfolio of companies like Instagram, WhatsApp, Messenger, and Facebook itself, all have an incredible potential to make more money.

These portfolio companies have become part of people's lives and our economy, and will continue to generate revenue and grow.

However, the recent data leak story, European data privacy law, GDPR, U.S senate panel hearing on the data leak, and the FTC investigation all create a bad news environment forFacebook.

Even though FB's earning will continue to grow, the earning multiple will be negatively impacted because of the constant news about FB's future with regulators that has a possibility of impacting its business model.

Even before the Cambridge Analytica story came out, there has been a dark cloud over Facebook from the speculation that Russian hackers manipulated the presidential election of 2016 through social media. I saw that as a bad sign on two levels – Facebook user, and investor. On the personal side I began posting less info about me and my family on FB and removing any unnecessary info about me that my friends don’t already know. And from an investing standpoint, I looked for a good opportunity to get out of the stock completely, not knowing what the Mueller FBI investigation was going to reveal. I had been trading the stock since it was around $75, and got out completely in January of 2018 when it peaked around $190.

Since the Cambridge Analytica story broke, I have been counting my blessings, and am happy that I stuck to my strategy for this stock and did not get greedy. Going forward though, FB is a little tricky. It is still a crazy money maker of a company. With incredible assets like Instagram, WhatsApp, Messenger, Facebook itself and others, it has an incredible grip over marketing and advertising. Instagram is used by many to follow their passions, and bring along their followers, and make money doing so. It has become a solid addition to the gig economy. Messenger, similar to other FB assets is generating revenue through advertising because of its billions of users. WhatsApp which likely generates the least revenue of these assets, is very promising. Based on the current user growth trends, its user base will likely surpass that of Facebook in the next couple of years. And if my contacts in India and Latin America are any indication of the indispensability of the app among users outside of U.S, there will be much bigger base for Facebook to grow its revenue in many ways. Given all of these strong growth factors, why is this a bad stock? Its not, if you are long on it, and don’t plan on, or need to sell it within the next year. However, if your goal is to trade it, and make money in the short term, there are many negative trends to watch out for.

And all of these negative trends are originating from capitols of countries. Europe is getting ready to launch GDPR which obliges any business that collects personal data legally to protect it from misuse and exploitation. That means any company that violates this can be penalized with millions of dollars in fines. It is very likely that FB will be one of the first companies that is scrutinized and penalized due to the Cambridge Analytica story.

Things aren’t any better for FB in Washington D.C either. Mark Zuckerberg will be testifying in front of a senate panel very soon, and will likely be questioned about the business model of Facebook, and if it is good for America. Whether it is or not, is not important for the Facebook investor, but the fact that this question is asked and is discussed in homes will likely have the effect of a continuation of the #deletefacebook movement.

Normally, data breaches are only given lip service by politicians, if the Equifax data breach was any indication. However, the personal data leak of 50 million possible voters is a little different. One thing politicians care about more than anything else is their own jobs. If their voting citizens can be influenced, whether knowingly or not, will be of a very high concern to the regulators. Given that GDPR is being launched in Europe around the same time as Mark Zuckerberg being questioned by a senate panel will certainly push the U.S regulators to begin thinking about similar laws protecting individual privacy.

So there is enough negative counterweight to the positive revenue generating capacity of Facebook that causes me to hold back and adopt a wait and see approach. The negative news impacts the earnings multiple because of wariness about the company's future with regulations and possible fines, or even its business model. So even if the earnings continue to improve in the next couple of quarters, trading Facebook to make money is extremely risky at best.

Once the midterm elections have passed, it will be a little bit more clear if the U.S regulators are truly headed down a path that will impact data privacy or not. Until then, their lip service to the data leaks will be enough to impact the PE ratio, and therefore the stock price itself.

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