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Cambridge Blues: Can Facebook Sidestep the Data Scandal?

“The biggest challenge for investors is to look past the multitude of (mostly negative) headlines about Facebook and look at the facts and metrics that drive the business case.”

Facebook’s status as the darling of the social media scene has been called into question in the wake of the high-profile Cambridge Analytica scandal. Users are said to be quitting the platform in their droves, but should investors follow suit or is the business case still strong?

  • The Cambridge Analytica scandal has raised serious concerns about Facebook’s control over data
  • Facebook’s earnings growth and user base have so far remained relatively unharmed
  • Investors need to sort through the media noise to understand the underlying business case

The emergence of social networks

From Facebook to Twitter, Snapchat and LinkedIn, it’s hard to remember a time when society wasn’t dominated by social media. The phenomenal growth of such platforms since the early 2000s has seen them become firmly engrained in the way we interact with our peers.

Early platforms like the now-defunct Friendster, Friends Reunited and LinkedIn, which now has more than 460 million members, first introduced the concept of social networking 15 years ago. Offering users the opportunity to find long-lost friends, meet new people and make business connections at the touch of a button, their popularity spawned a wave of other platforms, including Twitter, Myspace, Reddit and Orkut. However, it wasn’t until a group of Harvard students founded ‘Thefacebook’ (as it was then known[1]) in 2004 and then launched it as Facebook two years later that social networking really took off.

By 2009, millions of dollars had been invested in Facebook by Silicon Valley heavyweights, including PayPal co-founder Peter Thiel. Its ease of use, memorable name and clever advertising helped turn Facebook into the default social app , with the number of monthly active users reaching an impressive 2.2 billion.

Controversy strikes

For a while it seemed like social media platforms could do no wrong, but as the number of users grew so did concerns about security. This came to a head in March 2018 when news of the Cambridge Analytica-Facebook scandal broke. Cambridge Analytica, a data analytics firm, used personal information harvested from more than 50 million Facebook profiles to build a system that could target US voters with personalised political adverts.

The scandal led to widespread public and political discussion on ethical standards for social media companies, in addition to wiping billions off Facebook’s stock valuation in the weeks following the media coverage.

Since then however, the company’s share price has recovered. This was helped by its chief executive Mark Zuckerberg publishing a personal letter in several newspapers apologising for the errors, providing ten hours of testimony to the House and Senate committees, and pledging to make changes to Facebook’s policy to prevent similar breaches. In April, the company said it would implement the EU’s General Data Protection Regulation (GDPR) in all the countries it operates in.

Facebook’s first earnings report since the scandal broke have also helped to alleviate investors’ fears. The platform’s results were well above analysts’ expectations, with a 49% year-on-year rise in revenue and solid user growth.

Analysing the investment case

So what does the Cambridge Analytica scandal mean for Facebook investors? Is the platform doomed to failure or can it move on from its mistakes?

A useful way of analysing Facebook’s investment case is to look at the company’s four main revenue drivers: users, time spent on the platform, advertising load and price point pressure.

  • Users

According to the media, hordes of users threatened to quit Facebook, yet the latest figures suggest few have actually left the platform. At its peak, the hashtag #DeleteFacebook had only 62,000 mentions, which for a platform with 2.2 billion monthly active users is a drop in the ocean. And even though user growth in developed markets has slowed, for people in emerging markets like India and Indonesia Facebook is an increasingly popular and compelling service.

  • Time spent on the platform

The average Facebook user spends about 40 minutes every day on the platform. That might not sound like much, but it’s higher than for most social media platforms and surprisingly, is more time than the average person spends reading, exercising and eating each day.

  • Advertising load

Advertising load refers to the number of adverts a user sees in those 40 minutes they spend on Facebook. The platform recently revamped its news feed algorithm, to push posts from family and friends higher in people’s feeds, at the expense of posts from brands and publishers. Zuckerberg said this could result in people spending less time on Facebook – and it would logically follow that this would equate to fewer ads being viewed. Facebook has guided investors in the past that ad load will not increase, to maintain the user experience.

  • Price point pressure

Price point pressure takes into account the cost per impression (CPM) – the biggest driver of revenue growth at Facebook. In January and February, CPMs rose by 122% and 77% year-on-year respectively – the two highest year-on-year jumps of the past 14 months.

These four revenue drivers have to be looked at within the context of the data breach scandal. It’s clear there will be some regulation of Facebook – and other social media platforms – going forward. However, this is likely to focus on ‘honest ads’ rather than a huge clampdown on sites, with the US currently proposing the Honest Ads Act to bring accountability and transparency to online political adverts. 

At Senate hearings on the issue the committee seemed confused about how the ad paid business model works, but it has been well justified by Zuckerberg. It leaves the door open for a premium service to be launched for users who are willing to pay a small fee (perhaps $3 to $5 a month) in return for an ad-free experience.

The biggest challenge for investors is to look past the multitude of (mostly negative) headlines about Facebook and look at the facts and metrics that drive the business case. There is a lot of ill-feeling towards the site, but the latest results suggest people’s habits are hard to break. Once they start using Facebook, they’re unlikely to quit.

Weighing up the rivals

Facebook isn’t the only social media platform that investors can put money into, of course. Twitter and Snap, the parent company of Snapchat, are both listed on the New York Stock Exchange and appeal to different user demographics.

Yet Facebook is by far the global market leader. As of the second quarter of 2017, its revenue to monthly users was $4.65, compared with Twitter’s $1.75. Moreover, research from Forrester suggests that for every one million Facebook users, brands can expect about 700 interactions, versus just 300 interactions on Twitter.

Snapchat, meanwhile, has a young user base who are highly sought after by advertisers. The downside is that young people change their minds very quickly – if something new and better comes along they’ll switch without hesitation. With its broader user base, Facebook has an army of loyal followers – and in social media, scale matters.

Watch this space 

The furore surrounding the Cambridge Analytica scandal has abated in recent months. Investors need to remember that facts matter more than headlines. Facebook’s first quarter numbers were encouraging, but we can expect further scrutiny over future results, as well as the impact of new regulations such as GDPR.

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