The European Union's General Data Protection Regulation (GDPR) went into effect on May 25 this year, requiring companies like Facebook (META -0.46%) to update their privacy policies and enact new practices in an effort to better protect European user data from inappropriate use. At the same time, Facebook was still dealing with the fallout of the Cambridge Analytica debacle that resulted in the data of tens of millions of users falling into unauthorized hands.
The impact did not go unnoticed on Facebook's second quarter earnings. European daily active users in June fell to 279 million, down from 282 million in March. Facebook CFO Dave Wehner warned investors "European MAU and DAU may be flat to slightly down sequentially in Q2 as a result of the GDPR roll-out" during the company's first quarter earnings call. Importantly, he added, "we do not anticipate these changes will significantly impact advertising revenue."
Indeed, Facebook's European ad revenue grew sequentially to $3.25 billion from $2.99 billion in the second quarter, posting results largely in line with Facebook's other reported geographic regions. That number may, however, be padded by foreign-exchange tailwinds.
So, should investors be worried about GDPR's impact on Facebook?
A look at revenue per user
One number that continues to stand out in Facebook's quarterly reports is the gap between user monetization in the United States and the rest of the world. During the second quarter, Facebook's average revenue per user was $25.91 in North America. Compare that to just $8.76 in Europe.
While there are some less wealthy countries included in the European region, that monetization gap leaves a lot of room for improvement for Facebook in Europe. Facebook notably extended its GDPR practices globally, so it's not as though European advertisers are operating under a different set of rules compared to North American advertisers. As such, investors should expect continued progress in monetizing European users.
Although user growth took a step back, that's not a death sentence for long-term user growth in Europe -- Facebook could gain back some of the users it has lost. But it's important for investors to realize that the market in Europe is fairly saturated, as well as in U.S. and Canada, where user growth has been largely flat for several quarters. When asked about European user growth so far in the third quarter during the second quarter earnings call, Wehner declined to comment.
GDPR will have a massive impact on profits
While there's still potential revenue growth in Europe for Facebook, management did provide quite a bit of bad news for investors during the second quarter earnings call. Wehner pointed out that profit margins in Europe and other regions aren't as strong as North America due to the higher fixed costs as a percentage of revenue. (That will presumably fix itself as Facebook improves user monetization.)
Management also spoke about how its increased investment in security features will negatively impact profit margins. The step up in spending on security and enforcing GDPR regulations will be felt through 2019, as Wehner expects growth in spending to outpace revenue growth. Long term operating margins should settle in the mid-30% range, down from 44% in the second quarter.
On top of that, the foreign-exchange tailwind Facebook benefited from globally over the past year is turning into a headwind starting with the third quarter, so revenue growth will be impacted by that as well. Overall, Wehner guided for a revenue growth slowdown in the high-single digit percentage points. For reference, Facebook grew revenue 42% year over year in the second quarter.
CEO Mark Zuckerberg was keen to point out that the pressure on margins is coming from an increase in spending on security without sacrificing investments in new products. "We run this company for the long term, not for the next quarter," he said in his prepared remarks.
With $42.3 billion in cash and investments, Facebook is certainly in a strong financial position to handle the pressure from GDPR in Europe and other security concerns throughout the world. The results and guidance for the rest of 2018 and 2019 look more like a set back than an underlying issue with the company, one that Wehner pointed out last quarter is something Facebook's peers also have to deal with. Therefore, Facebook's competitive position, particularly with advertisers, remains very strong.