Facebook (FB 0.71%) shareholders may have noticed the 20% sell-off in their stock at the end of last month. As one of them, I can assure you that it wasn't a great experience!
The sell-off -- which came after the company reported second-quarter results -- appears to be due to Facebook's intentionally slowing revenue growth, coupled with greatly increasing investments. Management projects a deceleration in revenue growth next year into the low 20% range, down sharply from last quarter's 41.9% growth, while projecting 2019 operating margins in the mid-30% range, down from 49% over the past 12 months. Though it's a near-term hit, the actions it is taking should enhance Facebook's moat over the long term. For long-term investors, these dips can often present buying opportunities.
Stories has unproved promise
There is such a thing in business as growing revenue too quickly. Businesses in hyper-growth mode can overextend personnel and controls. This happens often with financial services companies, but social media companies have many potential growth pitfalls as well. One particular risk is showing too many ads or showing the wrong kinds of ads near the wrong type of content. Either of these mistakes can turn off users and therefore long-term engagement.
In its renewed effort to foster more active connections on the platform, Facebook is now emphasizing its Stories feature, which enables the posting of videos that disappear after 24 hours -- essentially a ripoff from Snap's Snapchat. The company believes the Stories feature makes people more engaged on the platform, so it's worth it to promote it, just as the company promoted closer friend and family connections over the past year, at the expense of businesses' posts. Facebook started testing ads on Stories in May.
The near-term problem is that Stories has lower levels of monetization than the core news feed. When asked about Stories monetization growth, COO Sheryl Sandberg told analysts in the company's conference call in late July: "The question is will this monetize at the same rate as news feed. And we honestly don't know. We'll have to see what happens."
However, Sandberg also offered reasons to be optimistic:
The opportunity -- full-screen, authentic, very engaging, different formats than Feed -- gives us an opportunity to grow. We also don't have all of our advertisers yet creating Story ads. Obviously as more and more advertisers come in and do that, the more and the better ads we'll have.
Stories is a new format, so advertisers aren't coming up with as many ads for Stories as they have for the news feed. But with 400 million Instagram Stories users and growing, and with 150 million Facebook Stories users reported in May, that should happen over time.
Privacy issues take a toll
Facebook's biggest concern this past winter, in case you were living under a rock and missed the dustup, was around security and privacy on Facebook's platform. In the quarter, the company unveiled a number of initiatives that should strengthen privacy and safety over the long term, but these accelerated investments are affecting near-term financial results.
Europe just implemented GDPR, a comprehensive set of consumer privacy regulations to which businesses must adhere. Customers now must opt in to have certain information disclosed to internet services such as Facebook, and this caused Facebook's European monthly active users (MAUs) to decline by about 1 million last quarter. Still, considering Europe has 376 million Facebook MAUs, that's really a pretty small number.
There was also encouraging news on opt-in rates, with management saying, "the vast majority of people affirmed that they want us to use information -- including from the Web Sites they visit -- to make their ads more relevant."
If people continue sharing data in exchange for free, ad-supported services -- which is the basic premise for much of the internet -- that means Facebook's core business of hypertargeted ads is intact, which is another great sign.
Unsettling content and propaganda get attention, too
A nagging concern on Facebook is inappropriate, offensive, or threatening content that turns people off and infuriates advertisers. In addition, the midterm elections are approaching, which will be the company's first large-scale U.S. election test since 2016 and the ensuing Russian propaganda scandal.
On the propaganda front, the company has built several transparency tools. One allows anyone to see any ad shown by a company, even if the ad hasn't been shown to you specifically. Anyone can now go to a company's page and see all the ads that company is currently showing across Facebook's properties. Another feature specific to political and advocacy ads reveals which company or group paid for the ad and how much it spent, and lists all the ads that company a group has run for seven years.
Content creators need policing, too, lest advertisers get upset. For instance, Youtube got in trouble last month, losing candy-maker Mars as an advertiser when the company found out its ads were showing up in videos promoting gang violence. On the recent call, Facebook also announced that it was investing heavily to prevent these types of incidents, claiming it was now capable of flagging or labeling almost 90% of graphic violence using artificial intelligence. Cutting-edge AI investments are costing money now, but will free up Facebook staff to concentrate on other (more fun) growth initiatives such as video, AR, and VR rather than constantly playing whack-a-mole with problem content.
Kudos to management
With its enormous scale and robust cash flows, Facebook has the luxury of spending heavily to ensure it doesn't repeat the mistakes of the past several years, and that's exactly what management is doing. These initiatives should further spur user engagement while widening Facebook's moat against competitors. Great companies often trade short-term pain for long-term gain, and that's just what Facebook is doing.