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How Coronavirus Could Damage Alphabet and Facebook's Ad Revenues

Companies are quick to rein in ad spending during times of economic uncertainty, and it may be only a matter of time before Alphabet and Facebook are impacted.
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So far, tech firms that operate in China have been among the hardest hit by coronavirus. But if conditions worsen, the damage may not be limited to companies like Microsoft  (MSFT) - Get Free Report and Apple undefined.

Market whiplash continued into Wednesday after the World Health Organization formally declared coronavirus a pandemic, sinking the Dow Jones Industrial Average 1,464.94 points by close of trading. And investors are scrambling to suss out what the economic damage may be the longer the crisis continues. 

"If you get an episode like this, people are just thinking about estimates at this time -- it's really hard to get a handle on whats going to happen over the next quarter, much less years," said Andy Braun, fund manager at Pax World Funds. 

Apple  (AAPL) - Get Free Report was the first major tech firm to warn investors of significant financial impacts related to coronavirus. Weeks later, Microsoft  (MSFT) - Get Free Report followed suit in revoking March quarter guidance for its Personal Computing segment, which includes Windows OEM and Surface. The coronavirus outbreak caused widespread supply chain disruptions in China, with electronics makers among the most affected. 

If the outbreak leads to a wider economic downturn, as some investors fear, Internet giants may not be immune either. 

In a report published Wednesday, Neil Begley of Moody's wrote that an extended U.S. coronavirus outbreak could hurt the advertising sector, including Alphabet  (GOOGL) - Get Free Report and Facebook  (FB) - Get Free Report, both of which derive the vast majority of their revenues from selling ads. 

"If the virus spreads widely in the US, economic contraction and short supply of consumer products and durables is likely and would last through to the end of the outbreak, which could be more than one quarter. The effect on US media companies’ advertising revenue would be significant," he wrote. 

He noted that any pullback in spending may be a temporary event, comparable to what occurred in the aftermath of 9/11, rather than a years-long downturn such as the 2008 Great Recession. But companies are quick to slash advertising budgets when consumers seem less inclined to spend -- and that could hurt both demand and pricing in the digital ad market. 

No one knows yet how bad a U.S. coronavirus outbreak may be, or how long it will last. But when it comes to Facebook and Alphabet, there's another problem in assessing the impact: Unlike industrial firms for example, they haven't been around long enough to have weathered a similar event, a least not at their current scale.  

"Certainly advertising is on the more discretionary side of companies’ spending patterns...I'm sure it's a question that [Facebook or Alphabet] are thinking about internally -- how to model this, relative to past episodes," Braun added. 

Having been a public company since 2004, Google may serve as the best example of how digital ad revenues hold up in a downturn. Company reporting showed growth in ad revenues plummeting between mid-2008 and 2009, and growing just 3% in the second quarter of 2009. Then-CEO Eric Schmidt told investors that consumers were clicking on ads but not buying, hurting click-through rates. 

Nonetheless, Facebook and Google are very different companies now: Their ad platforms are more ubiquitous, and ad targeting is much more efficient. And it's indeed possible that coronavirus winds up a temporary economic shock rather than triggering a deep and extended recession

Still, don't be surprised if the outbreak winds up hurting Alphabet's or Facebook's ad revenue growth -- one of the core metrics investors look at, given their present-day standing as mature businesses. 

Digital ad firms "have yet to be tested with economic disruption or recession, but we think they are not immune to these cycles," added Begley. "We expect the growth in 2020 will decline from 2019, by at least 25% and as much as 50%, depending upon the length and depth of an outbreak."