Facebook Lacks a Quick Fix; Investors Should Keep Powder Dry

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For Facebook (NASDAQ:FB) bulls, it seems the worst isn’t over yet. After plunging 22% in just two days in July when it announced a disappointing second-quarter earnings report, shares have continued to slide. And this is happening at a time when other members of the FAANG group, Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN), have set new records.

How long will Facebook stock languish and is this a buy-on-the-dip opportunity for Facebook lovers? In our view, that time hasn’t arrived.

Facebook Lacks a Quick Fix; Investors Should Keep Powder Dry

Facebook (FB) – 1-Year Chart

First, the company has to spend billions of dollars to satisfy regulators, politicians and the general public that its network is safe after it faced the public backlash, triggered by Russian interference in the U.S. election and the Cambridge Analytica scandal.

Facebook’s spending on infrastructure and security — including plans to hire thousands of people to work on investigating issues with fake news and election interference — will jump 50-60% this year and will outpace revenue growth in 2019, Chief Financial Officer David Wehner said on the July 25 earnings call.

And capital expenditures, which include spending on physical assets like data centers and equipment, is likely to increase to $15 billion in 2018, more than double the amount the company spent last year.

In a recent blog post, Facebook said it’s working to build new technology and partnerships to tackle misinformation on its network and it’s expanding fact-checking for photos and videos to all of its 27 partners in 17 countries around the world.

Facebook is much “better protected” against political sabotage today than two years ago, Chief Executive Officer Mark Zuckerberg said in a separate post published a day earlier, where he highlighted his plans to remove fake accounts and boost security on its popular properties.

All these spending and new measures suggest that Facebook is trying hard to avoid regulations that could alter its business model in a big way. But there is a huge cost to achieve that goal.

User Engagement on the Decline

The second threat that will continue to put pressure on Facebook’s stock is the extent of damage that these measures will have on overall user engagement.

According to a Pew Research Center survey released this month, Facebook users are adjusting their digital behavior following the backlash the social media giant faced after the 2016 U.S. presidential election.

More than half of Facebook users in the U.S. said they’ve changed their privacy settings in the past year, the survey found. More than four in 10 users have taken a break from the social media platform over the same time frame. And a quarter have deleted the Facebook app from their phone.

In the company’s latest earnings report, Facebook has shown that revenue growth has slowed dramatically in that quarter from about 40% to 20%. And the biggest factor that will set the future direction of Facebook stock is how quickly Facebook overcomes these challenges and arrests this deceleration in revenue growth.

We will know this in the next few weeks when the company releases earnings. Remember, Facebook has a history of giving conservative forecasts and blowing past expectations.

Bottom Line

There doesn’t seem to be a quick path to a Facebook stock rebound. All the extra spending, new regulations and slowing user engagement make a toxic combination that equals slowing revenue growth in the short run.

But if you’re a long-term investor, Facebook is a great name to own once the regulatory risk out of the way and the company’s revenue has stabilized. Even with all its troubles and negative publicity, Facebook is still running a hugely profitable business, expecting to make margins in the mid-30% range this year.

Buying Facebook stock on its latest dip means that you will be betting on the company’s long-term potential. With more than 2 billion monthly users and untapped properties, such as Instagram and WhatsApp, we don’t think that will be a wrong bet.

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