Business Technology

Thursday 20 June 2019

Four reasons why it all went so wrong for Facebook, so suddenly

Facebook CEO Mark Zuckerberg had warned investors that changes could affect growth. Photo: Reuters
Facebook CEO Mark Zuckerberg had warned investors that changes could affect growth. Photo: Reuters

Shira Ovide

What happened? That's what many of Facebook's investors - and I - have spent the last days wondering. On Wednesday, the company posted disappointing figures for second-quarter revenue, user growth and profits.

Executives also warned that Facebook's rapid rate of revenue growth would become relatively pedestrian the rest of this year, and that a surge of spending would drastically drag down profit margins for the next several years. During a conference call with stock analysts, nearly every word out of executives' mouths was more alarming than the last.

The reaction was utter panic. Facebook shed more than $120bn in stock market value on Thursday - the biggest single-day loss of market value ever for a US public company. To be fair, Facebook is still valued at more than $500bn, about where it stood at the beginning of May.

Now the question is what went wrong, and how much Facebook, its stockholders and the rest of the technology industry need to worry about the company that has been the biggest success in tech in the last decade. Here are four possible explanations for what happened, and how bad it is for Facebook and beyond:

1. A communications breakdown: Bloomberg's Jonathan Ferro suggests that what happened on Wednesday was a failure to adequately flag warning signs to Facebook investors. The explanations given for an expected slowdown in revenue growth later this year - a drag from fluctuations in foreign-currency rates, a shift in priorities to newer types of internet activity that generate relatively lower ad sales, and decisions to be less invasive in harnessing user information - seemed to come out of the blue.

Sure, Facebook had been promising to go big on the Stories format, currency swings aren't necessarily predictable, and CEO Mark Zuckerberg had warned that changes to limit the mindless use of Facebook could hurt business. But the company wasn't explicit before on the possible scale of impact from the changes to its internet hangouts. If the company could predict this, then management failed to properly set investors' expectations.

2. Investors didn't take Facebook's hints: While investors could justifiably claim surprise at the forecast of a growth slowdown, perhaps they shouldn't have been surprised about squeezed profit margins. The company has been saying for months that it was increasing spending drastically for a range of priorities, including hiring more people and devoting more technical resources to prevent its digital hangouts from being overrun by misinformation and propaganda. Facebook is also doubling down on programming for its web video services and for its global network of computer data centres.

The company forecast that its operating costs would increase by as much as 60pc this year compared with 2017, although analysts tended to dismiss that forecast as too high.

It now looks as though that estimate won't be far off. To defend investors, however, perhaps the most alarming thing in Facebook's litany of alarms was a prediction of operating profit margins somewhere near 35pc over the next several years. That is a stunning deceleration both from recent history - that margin was 45pc in the first half of 2018 - and investors expected profit margins around 44 percent in 2019 and 2020.

3. Facebook is being intentionally overcautious: Nearly two years ago, the company sparked a mini-panic when it cautioned that its revenue growth rate would "meaningfully" slow around mid-2017 because they couldn't keep shoving more advertisements into its social network. Investors worried for over a year and, in the end, the growth rate barely ticked down by late 2017.

It's possible, though unlikely, that Facebook on Wednesday was again lowering the financial bar so it can easily surpass its own forecasts later. Michael Nathanson, a stock analyst with MoffettNathanson LLC, also raised the possibility that Facebook is talking down its prospects "to stave off further regulatory pressure." The worse Facebook's financial results look, the less likely it will be that politicians and regulatory authorities around the world will target it for being too successful and powerful.

4. Things are going unexpectedly wrong: I lean toward this explanation, with sprinkles of the first three. I tend to believe Facebook was caught off-guard because of the simultaneous deterioration of user growth, particularly in the US and Canada, in its revenue growth rate and expectations for a further slowdown, and in its profit-margin forecast.

The split of ads compared with other types of information on Instagram signals that Facebook was worried about a slowdown it saw in usage or revenue growth on its social network so significantly stepped up the number of ads on the young and promising photo-and-video app. That smells like fear.

Maybe Facebook is doing exactly what it's been telling us for many months: Spending more and changing its priorities to ensure its digital hangouts are happier and healthier places. But I can't shake off the belief that Facebook saw all this coming, and its pledges about "time well spent" and cleaning up its act were defensive reactions to trends that weren't obvious to the public until Wednesday: Facebook was running out of steam. (Bloomberg Opinion)

Irish Independent

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