The plunge in Facebook’s stock is a stark reminder of the dangers of giving high-flying companies the benefit of the doubt.
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Should Wall Street have seen the problems brewing at Facebook?
The company’s stock plunged 19 percent on Thursday, wiping out roughly $120 billion of its market value, after it reported disappointing financial results that surprised investors and stock analysts.
Spotting trouble at companies is never easy. Senior executives often don’t go out of their way to shed light on difficulties, and they may be slow to see problems. But Wall Street firms and investment managers pride themselves on having a strong grasp of what’s going on at large companies. In Facebook’s case, they clearly didn’t, even though there was much that was concerning. Here are some of the things that were missed.
Before even getting to the political and regulatory pressures on Facebook, it’s important to remember that it’s not easy squeezing digital advertising revenue out of the clicks and swipes of social media users. The difficulties at Twitter and Snap in recent years have clearly shown this. How do you bring in new users, how do you keep them coming back, and how do you get them to click on ads? Investors assumed Facebook was different. The company’s ad revenue had surged since it began introducing ads and a large portion of what advertisers spent online went to Facebook. But after Facebook’s executives on Wednesday suggested growth might slow, investors have to contemplate that Facebook may not be that different from its mortal peers.
One of the biggest mysteries hanging over the company is whether its main Facebook website is becoming a drag on its business. If so, the company may be relying on Instagram and other products to bolster its growth, and they may still be too small to pick up the slack. Facebook does not break out how much advertising revenue comes from each product, however. This prevents outsiders from assessing whether the main Facebook website is becoming stale in its most lucrative markets, the United States and Europe. Investors often view a lack of transparency as a reason to be cautious about a company. With Facebook, they did not.
On a conference call with analysts on Wednesday, Facebook’s chief financial officer, David Wehner, said: “Instagram is growing more quickly and making an increasing contribution to growth, and we’ve been pleased with how Instagram is growing.”
When the Cambridge Analytica scandal engulfed Facebook earlier this year, its stock nose-dived. But investors piled back in after they apparently believed that users were not fleeing in large numbers and United States politicians would not introduce new regulations. Wall Street even seemed to get comfortable with the new privacy rules recently introduced in Europe, the General Data Protection Regulations, even though they were expected to prompt some European members to use Facebook less or delete their accounts entirely.
But the scandals and new rules may be creating an environment in which people become less enthusiastic about Facebook’s platforms and use them less, further slowing growth in advertising revenue. User numbers fell in Europe in the second quarter.
Protecting Facebook from dangerous content is also expensive. The company has made it clear recently that it would spend large sums (though it does not disclose how much) to prevent election meddling and stamp out hate speech, but investors may have underestimated the costs. These investments will be worth it, if they prevent future abuse of Facebook’s network. But investors may only now grasp that policing the biggest information exchange in the world does not come cheap. Content monitoring expenses, along with the costs of keeping the network engaging for users and profitable for advertisers, are contributing to a surge in spending that is eroding its profitability. Facebook’s revenue in the second quarter grew 42 percent from a year earlier, but its total costs grew 50 percent.
