Facebook – Broken Valley pt IV.

Another move-fast service that broke.

• Facebook has disclosed that it has been hacked with the loss of data from about 50m of its users which will only serve to further undermine faith in Facebook, belief in its commitment to security and privacy as well as its AI.
• Facebook has discovered a flaw in one of its functions called “view as” which allows users to view their own profile from the point of view of a stranger.
• Ostensibly, the idea behind the service is to allow users to have a clear picture of exactly how much of their lives is in plain view but there was a problem.
• The service had a vulnerability that, when exploited, allowed an attacker to steal access tokens that would allow the attacker to take over the account.
• Up to 50m accounts are affected where Facebook knows that the vulnerability has been used but it is not known if the accounts or the data stolen has been used for any nefarious purpose.
• However, to be safe, Facebook has reset the access of a further 40m accounts bringing the affected total to 90m.
• Given the problems that Facebook is facing, this is absolutely the last thing it needs.
• This is especially the case as the “move fast and break things” way of doing things badly needs to change (see here) and this looks like yet another example of something that was rushed to market without the proper testing.
• Facebook’s weaknesses in AI are forcing it to increase OPEX such that operating margins will fall by 1000bp or 10 whole percentage points over the medium term.
• This combined with its fake news problem and the fact that it is widely viewed as playing fairly-fast and loose with user privacy and security, is only going to make matters worse.
• Facebook’s overall strategy is to become a fully-fledged ecosystem where users spend the majority of their digital lives compared with the social network that it is today.
• In order to achieve this, it needs to be able to know in real time exactly what is going on in its network and to take the appropriate action.
• It also needs this information to make its service better and more engaging which will be a requirement if it wants users to spend all their time engaged with its services.
• Facebook has hired some of the best minds in the industry and, as long as they are not spooked by the recent falls in the share price, I think they can fix these issues given enough time.
• Assuming this is successful, long-term revenues and margins should end up higher than where the company is indicating today.
• However, the short-term obsessed market is always going to focus on bad news and falling margins and so I see pressure on the stock’s valuation for some considerable time to come.
• Hence, it is probably not too late to reduce a position in Facebook.
• Now that reality has made it over the horizon and sentiment has really soured, I am now looking for the time when Facebook completes its ecosystem, gets its AI right and reduces its headcount.
• These are the signals I am looking for as it is these that will herald a reacceleration of revenue growth and a return of margins back to the mid-40s.
• I may have a long wait.