Facebook Q4 18 – No-one cares.

Facebook users & clients don’t seem to care about its’ issues.

• Facebook reported good Q4 18 results confirming that its users and its clients do not seem to care about the privacy issues that have tied up the media and regulators up in knots during 2018.
• Hence Facebook’s real problem remains AI which is responsible for its falling profitability where margins took a 500bp hit during 2018 with another 500bp set to come out in 2019.
• Q4 18 revenues / EPS was $16.4bn / $2.38 nicely ahead of consensus of $16.4bn / $2.18.
• User numbers are up 9% YoY to 2.7bn of which 2.0bn people engage with at least one of Facebook’s Digital Life services on a daily basis.
• All of this good news and some clever tax accounting has masked the real structural problem that Facebook has.
• This problem is that Facebook has employed armies of humans to ensure that the data that users are posting is both appropriate and remains secure.
• As of the end of 2018, Facebook had 30,000 people working on safety and security meaning that a large portion of the entire workforce is engaged in non-revenue generating positions.
• Facebook needs 30,000 humans because its AI is too stupid to do this task effectively.
• To make matters worse I have long believed that humans are ill-suited to this sort of work because by the time they find objectionable content, it has already been viewed by millions of users.
• The impact of this large cost increase has partially been felt during 2018 and there is more to come.
• For example, Q4 18 operating profit grew by just 6% YoY despite the 30% YoY growth in revenues as costs increased as a percentage of revenues in all areas.
• In many growth companies, this sort of cost expansion is made as an investment in future revenue growth but this is not the case here.
• The 30,000 humans doing the checking are pure cost and will offer no revenue upside at any point in time.
• This is why there is more margin pressure to come in 2019 where I would expect margins to decline by another 500bp to around 40% down from the 46% reported in Q4 18.
• This means that revenue needs to grow by 23% just to keep operating profits flat YoY.
• Any less than that and Facebook will be in negative territory.
• This is a distinct possibility as revenues are currently growing at 30% YoY and significant deceleration has been forecast by management for 2019.
• This remains the key risk for Facebook going forward and I think that this will keep a lid on performance until this issue has fully played out.
• I am still steering clear of Facebook as I am waiting for improvements in its AI as well as greater maturity in its ecosystem to become interested once again.