Earnings season is well underway for social media and internet companies. Over the past few days, Twitter (TWTR - Get Report) and Snap (SNAP - Get Report) delivered financial results that did not quite please investors. In Twitter's case, it experienced a major stock selloff that reflected internal product issues and unfavorable seasonal effects that, to be fair, had started to improve late in the quarter.
Yet, usage metrics continue to look robust across the platforms, suggesting that social media remains popular despite concerns over personal data sharing and dissemination of inappropriate content, including the infamous "fake news." In addition, Twitter's and Snap's ad engagement and click through rates have remained strong, driving per user revenues substantially higher over 2018 levels.
Therefore, given the overall sector trends in usage and ad conversion unveiled so far, it is reasonable to expect that Facebook (FB - Get Report) will report decent third quarter results on Oct. 30, after the closing bell.
As the chart above illustrates, the company has been growing daily active users consistently for several quarter, with strong growth in emerging markets outside North America and Europe presenting a long-term opportunity. Meanwhile, increased monetization in developed countries, particularly in the United States, should help the company to reach analysts' 26% revenue growth expectations in the third quarter, a figure that looks de-risked relative to what Facebook has been able to deliver recently.
But Regulatory Challenges Are Sizable
Despite the upbeat short-term narrative, Facebook is still deeply involved with regulatory issues that will likely continue to plague it for many quarters to come.
The company is currently under investigation by the Federal Trade Commission, the Justice Department and 47 attorneys general over anti-competitive conduct. Meanwhile, CEO Mark Zuckerberg remains under scrutiny by Capitol Hill over handling of private data and the launch of Libra, which is now at risk as partners abandon the crypto currency project. The overhang of additional fines imposed by regulatory agencies, similar to or even more severe than the $5 billion settled with the FTC in July, remains a concern.
Even if potential penalties may not amount to much relative to Facebook's $70 billion in revenues projected for the current year, the Menlo Park-based company has clearly been sidetracked by regulatory noise. In order to address issues of security and privacy and to defend itself on multiple legal fronts, operating expenses have skyrocketed in the past few quarters. Instead of costs easing over time, the company's guidance keeps being bumped progressively higher.
Too Much Uncertainty
To be fair, some of the regulatory risk and increased expenses may already be reflected, at least partly, in Facebook's current stock price. Shares now trade at a forward earnings multiple of slightly less than 20 times which, in the context of EPS that is projected to grow at 20% over the next five years, points to a fairly conservative valuation.
However, I continue to believe that the uncertainties surrounding the company are too relevant to be ignored. While the social media business seems to be doing well across the internet sub-sector, investor sentiment could reasonably change on a dime as a result of factors that are outside Facebook's control. In addition, the company's bottom line could be at risk of deteriorating, should expenses continue to climb sharply as they have in the past couple of years.
For theses reasons, I believe Facebook is a stock to avoid, regardless of how the company may perform in the third quarter.
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