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Reports of Facebook's Decline Have Been Greatly Exaggerated

By Chris Hill – Updated Apr 10, 2019 at 9:55AM

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And worries about PayPal's shrinking profits should be taken with a grain of salt.

Facebook (META 0.81%) and PayPal (PYPL 0.42%) delivered earnings reports last week, and both surprised the pundits. Facebook, it turns out, has been shaking off the negative chatter -- and the higher expenses involved in upgrading its security and content governance. Revenue grew by 30% year over year, it beat expectations on profits, and Wall Street responded by rewarding the stock with its biggest post-earnings pop in three years. At PayPal, by contrast, profits fell 6%, and its expenses grew faster than revenue.

In this MarketFoolery podcast, host Chris Hill and senior analyst Jim Mueller take a closer look at what's going on with both of these companies, and talk about the details that investors should really be paying attention to beyond the headlines. They also discuss a pair of unsettling C-suite moves at Tesla (TSLA -1.41%) and Intel (INTC 1.70%).

Check out all our earnings call transcripts.

A full transcript follows the video.

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This video was recorded on Jan. 31, 2019.

Chris Hill: It's Thursday, January 31. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio -- we have a lot of news, and fortunately, Jim Mueller is here to help us out. Thanks for being here!

Jim Mueller: [laughs] Thanks, Chris!

Hill: We've got Microsoft. We've got Visa. We're not going to get to those. This is Earningspalooza week. We have so many things going on. We will probably get to those two on Motley Fool Money this weekend. For our purposes today, we've got PayPal's latest results, we've got executives that are very much in the news. 

We're going to start with the social network. Facebook's fourth-quarter revenue grew 30%. Profits came in higher than expected. Facebook shares up 12% this morning. That's the biggest gain for the stock post-earnings in three years. My first question is, are you surprised? Based on the coverage I've seen, there are definitely people out there who are surprised because 2018, from a headline perspective, not a good year for Facebook.

Mueller: No, it was a terrible year for Facebook. They've been guiding more expenses because of all the scrutiny they've been under and everything else. I think what's helping to drive the results this time is that Mark Zuckerberg, the CEO, said, hey, guys, we're kind of done with those; we'll still have higher expenses than in years past -- I've got a quote here. "We've made real progress in many of these areas," about improving security, content, governance, data privacy, that kind of stuff. That's what everyone's been worried about. And Zuckerberg said, "We've made real progress in many of these areas. We believe we built the most advanced systems in the world, and in many cases, more advanced than any other company or government."

Hill: Well, that's bold! [laughs] 

Mueller: [laughs] It is. If I was worried about Facebook's privacy stuff then, yeah, those words would go a long way toward relieving that worry. So, now, paired with that, they're saying, "OK, we're going to start paying more attention to building new ways for people to use the site and for us to get more ways for advertisers to get into these things." For instance, they have about 7 million total advertisers across their entire system. Only about two million of them are advertising on Instagram Stories, and Stories is growing pretty healthily. So one of the ways they're going to grow is to get more advertisers on Instagram Stories. 

Hill: You mentioned the expenses. I think that's something that really needs to be highlighted here in this regard: A year ago, we were in this studio talking about how Zuckerberg had come out and said, "Look, we're going to be investing. We're going to be hiring people to focus on security." We didn't know what the numbers were going to be, but we knew expenses were going to be higher because he was very blatant about that, very transparent about that. Now, we've got a fourth-quarter report where we can see for ourselves what the expenses are. And they're still growing revenue, and they're still growing their profit. 

Mueller: Yeah, they're still growing revenue. Not as fast as they had been. For the full year, they grew revenue by 38%. For the fourth quarter, as you said, they only grew by 30%, which means it was growing faster earlier in the year. Actually, for every single quarter of 2018, the revenue growth slowed down year over year as you went through the year. They're only guiding 24% to 26% for the first quarter this year. So, yeah, the expenses are still a big deal. But, we know where the expenses are going. They said they've grown their security employee base from 10,000 to 30,000 people over the past year. That's quite a big improvement. They're spending a lot of time and effort doing that. I think a lot of the enthusiasm in the market right now is, "Hey, it's working!" 

Hill: "This wasn't as bad as we thought it was going to be."

Mueller: Yeah. But I still have a little bit of worry in the back of my mind. Zuckerberg certainly sounded enthused. "Hey, we've got the best in the world! Better than governments, even. We're hot stuff, right?" But in contests or battles like this, Facebook is always going to be on the defensive. They've got better AI at identifying bad actor posts, for instance. But those bad actors are not going to say, "Oh, darn, you got me! I'll go find someplace else to do this." They're going to say, "How do I get around what they've got?" And they'll find a way, and then Facebook will react, and they'll find another way. The offense here is always going to have an advantage. I'm worried that Facebook might sit back on its laurels saying, "Hey, we've got the best in the world," and not continue to fight the good fight, so to speak. And if they sit back, we could very well see them in front of Congress or the European Union again.

Hill: Also, [laughs] Facebook has to deal with Apple (AAPL 0.14%). I'm just going to read directly from a Wall Street Journal story. "Apple banned a Facebook research app for breaking its rules around data collection in an escalating battle between the tech giants over user privacy. Apple said it revoked Facebook's permission to maintain a research app that had targeted teens and young adults, paying them $20 a month to suck up their data and track their activity across different apps and web browsers. The tech news site TechCrunch reported on the Facebook research program earlier this week."

Mueller: This is just bizarre!

Hill: It is a little bizarre. It's a couple of things. It's bizarre. It bears watching.

Mueller: Yep.

Hill: And, this kind of flies a little bit in the face of what you were talking about in terms of Zuckerberg saying, "Hey, we're out there, we're being good actors!" It's not that, necessarily, what they're doing here is illegal, but certainly, in the face of Apple, Apple has decided, "No, you're violating our terms. We're not going to allow this app in our store. We don't like what you're doing."

Mueller: That was my very thought. Facebook is saying, on the one hand, "We're protecting users' data," and on the other hand, "We're paying people to suck up that data." And Apple is saying, "No, that violates our terms because you're using something that's meant for research out in the public sphere." One quote I like is, what are people doing with the money they're being paid for? And one college student said, "Oh, I was buying video games and Axe body wash." [laughs] 

Hill: Sounds about right!

Mueller: Sounds about right. This isn't the first time Facebook has done something like this, either. Everyone in this field is desperate to get data in order to figure out, for example, what your opponents are doing. Facebook did a very similar thing with Onavo a while back, another data-sucking app to figure out what people are doing. Before they bought WhatsApp, they'd noticed that people were using WhatsApp more and more, and that growth of that was skyrocketing, certainly faster than Facebook's own version of that. That led to Facebook's decision to pay, how much was it?

Hill: $19 billion.

Mueller: $19 billion for it, several years ago. And now it's a big growth thing for them. But they kind of cheated to figure that out.

Hill: It's going to be very interesting to see how this plays out, particularly because while Mark Zuckerberg is pretty reluctant to do media, Tim Cook is not. I would not be surprised if Cook were asked about this the next round of interviews he did. 

Mueller: Another point on this is that Facebook only said, "OK, we're going to pull off this app," this latest one that they got caught on, after it had gotten out in the media. But Apple trumped them and said, "No, we're kicking you out.'

Hill: Let's move on to PayPal. Shares down a bit this morning. Fourth-quarter profits fell 6%. PayPal's expenses grew more this quarter than the revenue grew. I say, though, as a shareholder, I think there's still a lot to like.

Mueller: Oh, yeah! With this company, I'm not going to get too worried about varying amounts of revenue growth, as long as it's positive and healthy. With PayPal, I focus much more on to other numbers: the number of active accounts and how that is growing, and the number of transactions per active account. Both of those grew quite nicely. They had a record number of additions, 13.8 million net new adds to the active accounts. All but 2.9 million of those were organic. That roughly 11 million was the biggest amount of organic growth that they had ever seen. That's really good news. And not only more and more people are using it, they're using it more often. They're at 36.9 transactions per active account per month on a trailing basis. That's good. As long as they can keep on driving that, as long as they can keep on playing their, "We're going to be the mobile payments system of the world. We don't care who you are, where your money's coming from, what bank you're doing it with, what credit card or debit card you're doing with, we want to be in that transaction," these guys are going to do fine.

Hill: The Venmo activity continues to rise.

Mueller: Oh, 80% year over year on this one. And they're finally being able to monetize it. They've got the Venmo debit card, they've got Pay with Venmo, where you use Venmo at a merchant and they get a bit of that transaction.

Hill: They've also got $10 billion in cash on the balance sheet. 

Mueller: [laughs] Yeah. I'm not worried!

Hill: I mentioned we've got executives in the news this morning. I'm going to ask the dozens of listeners to stick with me for a minute. These are noteworthy announcements, possibly for different reasons, though. Tesla announced their fourth-quarter results, and they also sort of threw in at the end there, "Oh, by the way, the CFO is resigning."

Mueller: At the end of the conference call! It's not even in the earnings release!

Hill: This is Deepak Ahuja. If that name is familiar to Tesla shareholders out there, it's because this is the second time he's been CFO, and this is the second time he's resigned. This is not to be confused with last year, when not one but two Chief Accounting Officers resigned, one of whom resigned after being on the job for one month. 

The other executive in the news is Bob Swan. Robert Swan. I don't know him at all, so I don't necessarily know him well enough to call him Bob. Interim CEO of Intel who has just been named full-time. They've removed the interim label. The reason this is interesting is because the board of directors had been looking for a replacement, and Swan had been out doing interviews over the last couple of weeks talking about how, "We're going to have a new CEO." And they appeared to have locked in on a candidate, gotten far down the road, and couldn't close the deal for whatever reason. So, Swan, who was the CFO at Intel -- last summer, Brian Krzanich, who was the CEO at Intel, resigned, so they make Swan the interim. And now, he's got the job, because apparently he was doing well enough. 

I don't own either of these stocks, and I find both of these stories unsettling.

Mueller: For different reasons, definitely. A little personal history here. My first paid interaction with The Motley Fool, before I became an employee here, was paying for an online seminar called When To Sell. It gave several red flags, half a dozen or so, on when you should really think about selling your stock. And one of those was "sudden resignation in the C-suite." If you look at Tesla -- I did a little digging -- over the past four years, Tesla's had four different CFOs. Actually, two of them were the same person, Ahuja. He was there from 2008 to 2015, from just before they went public to 2015. Jason Wheeler took that job for 14 months, left in early 2017. He announced at the same earnings two years ago that Tesla just had, just before saying, "I'll be here until the 10-K is filed, then, bye." Then, Ahuja came back from retirement to step in, and he's been there for a couple of years now. And now, it's Zach Kirkhorn -- how do you say his last name?

Hill: We'll just call him Zach.

Mueller: Mr. Zach [laughs] is stepping up from, he had a role in finance, but it's escaping me at the moment. 

Hill: But this is his first job as a chief financial officer. 

Mueller: Yes. And for such a big company, that's kind of scary. And, not only the two chief accounting officers you mentioned, several other high-level managers, the chief human resources officer. That kind of turnover at such a high level, either Musk is really hard to work for, or there's something going on. As an investor, it really makes me leery. 

Hill: Yeah. As I said, it's unsettling because, as you've just said, there aren't a lot of reasons for this. If you're looking at the possible reasons for this type of revolving door in the C-suite at Tesla, the menu is not very large. 

In the case of Intel, this may be easier to explain away. It's entirely possible that they got a candidate that they really liked, and then they got hung up on the negotiating details, that sort of thing. Still, if you're Swan, you have to feel a little bit like you've been jerked around a little bit, just because you've been out there giving interviews saying, "Hey, the board is going to have a new CEO. We're excited about this. Blah, blah, blah." And then, it's like, "Oh, well, this person didn't want to go to dinner with us. Do you want to go to dinner with us?" Like, he's the clear second choice here. 

Mueller: Well, that's curious. What's even curiouser is that, I believe when he was first named interim CEO in a meeting with employees, he said, "I don't want the full-time job." [laughs] At least according to one report from somebody who was there at the meeting. And now, he has it. And he says, "I'm anxious to get going." But, I'm willing to cut Intel a bit more slack. They've had seven CEOs in 50 years. That's a pretty good record. Until last summer, Krzanich, who was basically forced to leave because of some impropriety, breaking one of Intel's internal rules, they'd had a very smooth set of transitions of those CEOs -- entirely, I believe, from the inside. So, between Tesla's CFO thing and Intel's CEO thing, I'm willing to cut Intel more slack than Tesla. 

Hill: Yeah, absolutely. Robert Swan, you look at his career, he's been the chief financial officer at, among other places, General Electric and eBay. He's no slouch. I am curious, though, with this as a backdrop, as an analyst, where do executives fall on your list of how you're evaluating a company? When you're looking at a business and thinking to yourself, "Do I want to buy shares of this company?," how soon into the process do you start looking at the leadership of the company? 

Mueller: It's probably the second or third thing I look at. First thing I look at is the sum of the financial statements, the cash flow statement, the balance sheet. Not so much the income statement. I want to see how cash is flowing through the company and whether they're making it. And, the balance sheet, how stable the company is. If I like that and I like what the company is doing and what it's possible to do, then I look at the management. I want a team that, one, knows what they're doing, and two, has been doing it for a while, or at least has relevant experience. Naming a longtime CFO to a CEO position, that's fine, or a chief operating officer, that's fine. 

This also ties into what the board is doing. Part of the board's governance, what they should have, is some sort of succession plan. Not only do CEOs get fired or resign, but they die. McDonald's back in the day, Cantalupo, back in 2004, died of a heart attack all of a sudden after being CEO of McDonald's for less than two years. They had a candidate, a person who was able to step up rather quickly. I ran across another company, Wilhelmsen, which is an international shipping company in Scandinavia. In 1989, they lost the top two layers of management in an airplane crash. It took them a while to recover from that. That's probably more than what you're expecting, but certainly, a board should have some sort of succession plan. 

It's the suddenness that I don't like as an analyst. But if it's well planned out and well thought out, and especially if it's telegraphed to the market, then yeah, I'm cool with it.

Hill: Jim Mueller, thanks for being here!

Mueller: Thank you!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you on Monday!

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Chris Hill owns shares of EBAY and PayPal Holdings. Jim Mueller, CFA owns shares of PayPal Holdings and has the following options: long January 2021 $150 calls on Apple, short January 2021 $160 calls on Apple, short April 2019 $85 puts on PayPal Holdings, long January 2020 $82.50 calls on PayPal Holdings, and short January 2020 $82.50 puts on PayPal Holdings. The Motley Fool owns shares of and recommends Apple, Facebook, PayPal Holdings, and Tesla. The Motley Fool owns shares of MSFT and V and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends EBAY. The Motley Fool has a disclosure policy.

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