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Facebook's Regulatory Issues Overshadow a Solid Earnings Beat

By Danny Vena - Jul 26, 2019 at 2:11PM

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The social media giant stepped out of the crosshairs of one investigation and into two more.

Facebook ( FB 3.60% ) investors have been enjoying what has been a banner year for its stock, so far. The stock had racked up 47% gains before the year was halfway over. That rate is remarkable considering the company was staring down the barrel of a Federal Trade Commission (FTC) investigation for the data-privacy scandal sparked by Cambridge Analytica all year. As a result of that investigation, Facebook agreed to pay $5 billion and submit to a host of oversight measures to settle allegations it misused consumer data.

So when the company reported second-quarter earnings on Wednesday, investors were feeling good about the stock and hoping the worst was over. Then Facebook disclosed, as part of its report, that the FTC had just started a new antitrust investigation into the company, while the Department of Justice announced that it would open an antitrust review of a number of big tech companies -- including Facebook. Looks like the investor worries are just getting started.

Facebook CEO Mark Zuckerberg holds a microphone as he addresses an audience.

Facebook CEO Mark Zuckerberg. Image source: Facebook.

What the earnings report showed

For Q2, Facebook reported revenue of $16.88 billion, up 28% year over year and an improvement on the 26% growth the company generated in the first quarter. The results sailed past analysts' consensus estimates, which called for revenue of $16.5 billion. While management doesn't provide quarterly guidance, it has steadfastly maintained that growth would decelerate by a "mid-single-digit" percentage in 2019, so the results were better than many investors had anticipated. 

Earnings were pinched as a result of the FTC fine. Facebook reported net income of $2.6 billion, down 49% year over year, as the company set aside an additional $2 billion (it set aside $3 billion last quarter) to cover the settlement with regulators. This resulted in diluted earnings per share (EPS) of $0.91, down 48% compared to the prior-year quarter. Excluding the impact of the fine, EPS would have been $1.99, compared to the $1.88 expected by analysts. 

Strong operational growth continues unfettered

Even in the face of all the negative press, Facebook continues to rack up strong user growth, which is particularly impressive when you consider how big the platform is already. The company reported 1.59 billion daily active users and 2.41 billion users who visit the platform each month, with both metrics up 8% year over year. Management estimates that more than 2.1 billion people used Facebook, Instagram, WhatsApp, or Messenger every day, and that roughly 2.7 billion use at least one of the platforms each month.

Mobile advertising again accounted for the bulk of Facebook's revenue, growing to $15.6 billion, up 32% year over year. Mobile is now responsible for 94% of advertising revenue, up from 91% in the prior-year quarter.

The average price per ad decreased 4% year over year in Q2, the result of a mix shift toward the Stories product and countries with lower monetization rates. Ad impressions on the platform increased 33%, driven by an increasing number of ads on Instagram Stories, Instagram feed, and Facebook News Feed. The average revenue per user grew to $7.05, up 18% year over year.

The investigations are just beginning

Facebook revealed details about its settlement with the FTC. In addition to the $5 billion fine, the company said it has agreed to "significantly enhance our practices and processes for privacy compliance and oversight."

On the earnings conference call, Facebook said the changes include "substantial management and board of directors oversight, stringent operational requirements and reporting obligations, and a process to regularly certify our compliance with the privacy program."

Management declined to provide any details about the two new investigations, other than a boilerplate statement contained in the earnings release:

The online technology industry and our company have received increased regulatory scrutiny in the past quarter. In June 2019, we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, in July 2019, the Department of Justice announced that it will begin an antitrust review of market-leading online platforms.

For investors who were hoping the worst of the regulatory scrutiny was over, this may be just the beginning. That said, financial and user metrics continue to trend upward, hinting that growth will continue, even as the gaze of regulators grows more intense.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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