Facebook follows new course with uncertainties – Syz AM

Associating Facebook with universal success and promptly applauding its impressive growth numbers (that have never failed to thrill investors) has been the norm in the past few years that we have been invested in the tech giant. But what happens one day when the positive quarterly surprise looks slightly less affirmative and shows qualms only natural for a maturing business that focuses on higher profitability instead of growth?

Conceivably, the management’s long-term vision for the Facebook brand was hard to fully comprehend and feed into analysts’ models, leading to a brutal and volatile stock price reaction in the aftermarket trades last night, throughout the company’s earnings call and after it.

Last Thursday (post-quarterly results), we probed into the changes the company is contemplating, to better understand if its diverse stakeholders, including global marketers, two billion individual users and even regulators and sovereign states, would endorse them.

To begin with, the company undertook what looks like an honest introspection, admitting that its algorithms had played a role in spreading fake news during the US presidential campaign and going as far as saying that excessive use of social media may negatively affect mental health.

The new algorithms should thus prioritise trusted sources, likely decreasing traffic, but increasing the quality of content and encouraging ‘meaningful social interactions’. By default, this is likely to decrease the quantity of feeds, as it reduces less user-engaging passive content such as viral videos and long posts.

What does this mean for the financial viability of the tech giant? It should result in some deceleration in sales growth from unsustainably high levels, but this is not necessarily negative, as it points to the maturity level attained by the business. Higher profitability, as global marketers put their faith in the platform’s prowess for reaching its target audience in a more meaningful way and agree to pay higher prices.

The path from here seems more likely to be led by profits than sales, but this is what a rational investor should expect from a maturing business like Facebook. The company continues to highlight other profitability levers, including greater monetisation of Instagram and WhatsApp.

The new surge in ‘story sharing’ tendencies places the two assets in a sweet spot. With over 300 million daily active users each, they are likely to continue dominating the story sharing product market.

To sum up, we believe that Facebook is following a new course, which is the right path for the company, albeit with some uncertainties. We see its global reach, coupled with enhanced user engagement, as a driver that will continue to make it the most attractive platform for global advertisers and marketers.

The company’s forward-looking multiples are reasonably cheap compared to both its own historic averages and those of its tech peers, especially given sustained profitability improvements and a very handsome earnings growth profile.

Shoaib Zafar is senior analyst at Geneva-headquartered Syz Asset Management.

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