The recent news surrounding the security of Facebook (FB) users’ personal data has dragged the stock down 7%. The controversy may further justify Europe’s General Data Protection Regulation campaign, the enforcement of which will begin in May, and increase the probability of similar demands in the U.S. We’ve accounted for such risk, to a certain extent, in our model, which has much lower than consensus projections over the next five years, but the news is concerning, and we continue to analyse possible impacts from it on our valuation of Facebook and its peers.
In the meantime, even with the recent pullback in Facebook shares, they remain in three-star territory, meaning they are fairly valued. Morningstar equity analysts are maintaining their $198 per share fair value estimate for this wide-moat name.
What is Cambridge Analytica?
The scandal has reignited the discussion and fear about the safety of private user data and how that data can be used by various groups, organisations, or companies. This specific issue began to unfold after reports that Cambridge Analytica gained access to the data of approximately 50 million Facebook users, which it may have used to target voters during the 2014 U.S. midterm elections and the U.S. presidential election in 2016. Cambridge Analytica a London-based data-mining and analytics firm providing strategic consulting for various politica campaigns, including Brexit in the U.K. and Donald Trump’s run for president of the U.S.
According to Facebook, Cambridge Analytica got its hands on user data by working with Aleksandr Kogan, a psychology professor at the University of Cambridge. Facebook had given him permission to operate an app for psychology-related research on the platform. However, Facebook claims that Kogan then violated the agreement and passed on the data gathered to Cambridge Analytica. Facebook has suspended Cambridge Analytica from the platform.
While steps have been taken to limit access to personal data via the Internet in Europe with the launch of GDPR, given the recent news about Facebook and Cambridge Analytica, similar regulatory steps may spill into the U.S., which historically has addressed privacy issues only when it is needed. The Cambridge Analytica controversy could be a clear indication that further regulatory steps must be taken in the U.S. to ensure consumer consent and to increase the safety and transparency of data usage, which may increase risks for firms such as Facebook and social media peers Snap and Twitter.
How is Facebook Impacted?
In our view, the amount of data collected by these firms may decline when forced to seek user consent. With data, or the intangible asset, growing at a lower rate, ROIs on the ad inventories sold by Facebook and other online ad firms could be negatively affected. If so, ad prices could decline, which may also decelerate growth of average revenue generated per user, or ARPU, which has been growing impressively, especially for Facebook.
In addition, we think that as user doubts increase about the overall security of private data, the probability of less time spent on the social network platform and of higher user churn can go up, possibly affecting the heterogeneous network effect moat source. However, with more than two billion users worldwide, Facebook’s network effect moat source and our wide rating on it is not at risk.
Further, Facebook is taking steps to maintain users on its network, including limiting ads sold on its news feed, prioritising user-generated content on the platform, and, as announced early on March 19, making it a bit easier for content creators to publish and promote on Facebook. We think these moves, along with further enhancements of data security, will help Facebook maintain its network effect moat source.
As mentioned earlier, even with the 7% decline in Facebook’s stock on March 19, we still view the company as a three-star name and continue to advise investors to wait for a wider margin of safety. In our view, Facebook shares may become more attractive at the low $160s levels.
The pull-down in Facebook shares have also dragged down Snap 4% and Twitter 2%. Snap is now trading near our $16 per share fair value estimate, while Twitter remains significantly above our $24 valuation. We recommend patience for further pullback before investing in either of these two names.
