Facebook Q1 18 – Eye of the storm

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There is worse to come.

• Facebook reported excellent Q1 18 results, but in my opinion, has yet to experience the impact of its current problems on its financial performance.
• I see this resulting in a relief rally, that represents an excellent opportunity to reduce holdings.
• Q1 18 revenues / adj-EPS were $12.0bn / $1.69 compared to consensus estimates at $11.4bn / $1.35.
• In addition to excellent financial performance, there was no perceivable impact on daily active users adding weight to Facebook’s assertion that the delete Facebook movement has had no effect on its ecosystem.
• This is the first bit of good news that Facebook investors have seen for some time, but I think that this is just the eye of the storm and that there is worse to come.
• This is because:
  • First, AI: This is Facebook’s biggest problem by far and it is going to hurt its numbers this year.
  • This is because its AI is not good enough to scan data for offensive content as it is unloaded to its service meaning that it has to rely on humans to do the job of the machines.
  • This will result in a 40-60% increase in OPEX this year which will hurt margins as revenue growth slows down from its current breakneck pace.
  • Second, time spent: Facebook is now emphasising community and interaction over watching videos.
  • This means deeper engagements on the service between users but less time spent overall.
  • In the long-term this will provide more valuable opportunities for monetisation, but in the short-term there is simply less inventory to be sold.
  • The net result is likely to be slower growth in revenues for 2018.
  • Third, programmatic advertising: data collated by Curation Corporation (see here) is hinting that there might be a problem with this system of advertising.
  • Specifically, while it has delivered great growth for Google and Facebook, it may have underwhelmed as far as a return on advertising dollars spent for advertisers.
  • The net result could be a move away from this advertising method towards other systems, resulting in weaker than expected revenues for the digital ecosystems who largely rely on it.
• Following these results, expectations for Facebook are likely to be on the up once again but this time I am unable to follow.
• I think that the issues around privacy, time spent, AI and potentially programmatic advertising will cause the numbers to disappoint this year.
• This will result in weakness in the share price and a rerating of the valuation.
• Long-term there could be upside as Facebook moves from being a series of services to a more immersive place for users to live their digital, lives but for now I see problems.
• I am heading for the door but I do intend to come back at some point.