We believe that Facebook’s greatest near-term risks arise from antitrust investigations and possible regulatory action. Since June 2019, the FTC, the U.S. Justice Department, the House Judiciary Committee, and attorneys general from 40 states have begun investigations into Facebook. It may only be a matter of time before Facebook (like Alphabet/Google) faces an antitrust complaint seeking either regulatory actions are perhaps even the break-up of the company.
The results capped another big week for Facebook, which included more congressional testimony from CEO Mark Zuckerberg (with what has come to be the usual bipartisan political drubbing).
Third-quarter revenue rose 22% year-over-year to $21.5 billion, well below the 27.6% growth in 3Q19, but not so bad given the impact of COVID-19. Positive foreign exchange movements added $114 million (1%) to revenue.
The 3Q bottom line was boosted by a one-time $0.31 tax benefit related to the capitalization of certain R&D expenses. Excluding this benefit, EPS rose 13%.
At the same time, Facebook’s digital advertising business has also recovered, as evidenced by the 22% growth in 3Q, more than double the 10% growth that management had expected.
We have noted Facebook’s ongoing work to police egregious content on its sites, which has continued in the run-up to the 2020 presidential election. Essentially, Facebook is looking to moderate posts advocating voter suppression, misinformation about voting or the election, and false claims related to winning the election. So far, the company has managed to avoid the debacles of the 2016 election cycle, while still irritating some on both the right and the left.
EARNINGS & GROWTH ANALYSIS
Management is focusing on a few major initiatives. One is achieving messaging interoperability among Facebook’s services, Facebook Messenger, Instagram, and WhatsApp. Facebook+ Messenger and Instagram are already interoperable in the U.S. and other countries. Management is working to unify messaging across all three, while at the same time adding features, particularly related to e-commerce on its messaging services. Another major initiative is Reels, essentially TikTok for Facebook. Management is cagey about the actual traction for Reels with Facebook users. A third initiative is AR/VR (augmented reality/virtual reality). The company released its newest VR headset, the Oculus Quest 2 in mid-October with incremental innovations and a lower price. So far, AR/VR has not set the world on fire, though Facebook management remains committed to the experience and has even signed a partnership with dominant eyeglass maker Luxottica. Can another attempt at AR/VR glasses be far in the future, despite the cautionary crash-and-burn tale of Google Glass a few years ago? The company has also introduced Facebook Rooms, and expanded the number of users who can participate in a call on the WhatsApp’s video calling service. Both of these new products are squarely aimed at the skyrocketing use of video calling, originally due to stay-at-home restrictions but now fast become a new consumer paradigm. As it has often done in the past, Facebook saw an opportunity with the popularity of Zoom Video Communications and essentially copied the idea. Facebook can also boast that WhatsApp is actually end-to-end encrypted, something that Zoom has only just achieved.
This compares to an 18% decline in 1Q20 and just a 1.4% increase in 2Q, both impacted by COVID-19 effects. While growth in ad impressions has been accelerating, the average price per ad has been decelerating. ARPU growth has remained quite strong, however.
However, management has introduced two new metrics ‘Family Monthly Active People’ (MAP) and Family Daily Active People (DAP). These metrics count a monthly or daily active person as a ‘registered and logged-in user of Facebook, Instagram, Messenger and/or WhatsApp,’ who visited one of those services within the measurement period. The new metrics exclude multiple accounts and adjust for those using multiple applications. The company had 3.21 billion monthly active people in 3Q20, up 14% from the prior year.
Mr. Zuckerberg believes that video will be key to fueling Facebook’s next growth stage, and is one of the company’s primary investment areas. Management first identified member-generated short-form video as a means of boosting engagement. It has also begun to move into long-form professionally produced video with the ‘Watch’ tab. Facebook has worked to remedy this issue. While Facebook often relies on human checkers to flag objectionable content, the company is also applying AI technology across its product portfolio, including News Feed, search, advertising, security, and spam filtering.
MANAGEMENT & RISKS
iOS 14 is expected to include an opt-in feature related to user behavior tracking that could severely impair Facebook’s advertising-targeting algorithms, diminishing the usefulness of its advertising to advertisers. Management expects the iOS14 change to weigh on Facebook revenue in 2021.
The company may be awaiting the filing of an anti-trust complaint from the Federal Trade Commission.