Facebook Ad Boycott Has Potential to Be a Bigger Problem

Facebook investors will learn more about the impact of Facebook's civil rights issues in its second quarter earnings, but don't expect major changes before then.
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Facebook's fraught relationship with civil rights groups -- and now some advertisers -- shines an unflattering spotlight on certain aspects of its business model. And that creates risk for investors, as well. 

On Wednesday, Facebook  (FB) - Get Report released the results of a civil rights audit of its platform, which was led by civil rights attorneys over a two-year period. The audit observed "painful decisions" by the company that ultimately led to "serious setbacks" for civil rights, and expressed concern over Facebook's policy of not fact-checking posts from politicians, its treatment of voting-related content and other practices. 

“This audit has laid bare what we already know -- Facebook is a platform plagued by civil rights shortcomings," said The Leadership Conference on Civil and Human Rights and other leading groups in a joint statement. "Facebook has an enormous impact on our civil rights -- by facilitating hate speech and violence, voter and census disinformation, and algorithmic bias, and by shortchanging diversity and inclusion. This audit has exposed Facebook's vulnerabilities and provides important recommendations that they must take up swiftly."

Facebook shares were rising 0.7% in pre-market trading on Thursday to $245.39.

The changes sought by the civil rights groups include addressing algorithmic bias on Facebook's platform, more robustly enforcing its own community standards and ending disinformation and voter suppression for politicians.

However, Facebook appears reluctant to commit to some of these changes, at least right now. Facebook has repeatedly batted down shareholder proposals having to do with civil rights. And a meeting on Tuesday between Facebook management and organizers of a widely-publicized advertiser boycott reportedly did not yield a satisfying compromise

"I think [the ad boycott is] not yet material, but it has the potential to be a digital ad wildfire because it strikes at the heart of Facebook’s vulnerability: an algorithm powered by a focus on content that captures and arrests the emotions of its users, which divisive, race-oriented content tends to do,” said Eric Schiffer, the chairman of investment group Patriarch Organization. 

Facebook's ability to engage users has made the company enormously profitable. But advertisers, including both major global brands and small businesses, are taking a harder look at whether they want their brands to be associated with divisive and objectionable content. 

In a recent note, Needham analyst Laura Martin wrote that some brands are likely to shy away from Facebook through the November election, and that advertisers  are eager to loosen the company's "iron grip" on their advertising budgets regardless. Some could reallocate budgets to less controversial alternatives such as Google  (GOOGL) - Get Report, YouTube, Amazon  (AMZN) - Get Report or Pinterest  (PINS) - Get Report

Facebook has overcome major scandals before, and it can do so again. But it's "going to have to go a lot further" to mollify advertisers, Schiffer added. Additional measures could include more labeling of problematic content and a greater focus on creating a "safe harbor" for brands that don't want their ads near divisive or racist content. 

But don't expect Facebook to hamper or cut off revenue streams on a voluntary basis. Despite recent efforts to introduce more payments and commerce on its main platforms, Facebook still gets the vast majority of its revenue through advertising. And the trajectory of its past scandals, notably Cambridge Analytica, suggests that Facebook won't upset the apple cart until it is determined to be in the company's financial interest. 

"They're not going to want to shut those rivers down unless they are forced to at their own economic peril," Schiffer added. 

Facebook's second quarter earnings, which are expected on July 29, could give a clearer picture of the boycott's impact on the company's balance sheet. Right now, Wall Street analysts are projecting $75.5 billion in advertising revenue for the full year, on average, and $17.1 billion for the current quarter. A few have lowered their estimates for Facebook's full year partly based on the impact of the boycott. 

Facebook investors appear largely confident in the company's ability to withstand the current storm and to introduce new revenue streams over the long term. But pain could arrive if the impact of the boycott is worse than expected, or creates a sustained impact on the company's finances. That was the case after the Cambridge Analytica scandal in 2018, when Facebook's disclosure of heavier spending on security and privacy led to a weeks-long selloff in the stock and other headaches for the company, including regulatory action. Shares ultimately rebounded, however, and are now trading at close to all-time highs. 

Year to date, Facebook shares are up 16%. 

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