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Huge Unknowns for Facebook

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I've been a Facebook (FB - Free Report) investor for about two years, ever since I discovered the true strength of their advance in digital advertising, as their 40-50% annual growth rate in the space would soon have them equaling the mighty Alphabet (GOOGL - Free Report) .

But I started to get a little nervous as rumblings intensified about the social media giant's impact on the 2016 presidential election, especially as large consumer products advertiser Unilever (UN) decided to walk away from the platform.

Here's what I told my TAZR Trader members on February 7 after Jim Carrey "un-friended" FB in widely publicized message urging others to #DeleteFacebook...

Thanks a lot, Jim. You have successfully closed the barn door after all the horses have run out. Yeah, Facebook screwed up by letting their automated ad platform generate big revenues with little oversight.
 
And they have been ahead of regulators on correcting the problem. But it's a pretty unique problem if you think about it.
 
Did you imagine this type of Orwellian misinformation and fake news happening in this decade of sophisticated, technologically-savvy consumers?
 
Wait, don't answer that. Of course you did.
 
It's the scale and power most of us didn't consider being possible.
 
I'm a Facebook investor because I believe the platform will evolve and continue to create communities where advertisers can "find their people."
 
But I could be wrong. Sentiment like Carrey's could devastate any successful platform if there is an angry-enough backlash among millions of users.
 
Of course, FB has billions and they're still growing globally.
 
It will be a historic evolution in social media... and in politics and culture. I'm glad we are here to watch it unfold.
 
I can't tell you right now if I'll for certain add to FB shares if they fall to $150, but I am strongly considering it.

(end of Feb 7 comments)

And on Feb 12, I was taking a closer look to see if Wall Street was changing its growth outlook on FB...

My top and bottom lines on FB: The growth estimates (primarily from advertising) have not yet been impacted by any of this, at least not anymore than analysts saw coming and then reacted to after January's change in the NewsFeed (most went up). Until estimates are impacted, we are looking at 36% top line growth this year to $55 billion and a 27% advance next year to $70 billion. And 16% EPS growth this year to $7 and a 28% rebound next year to $9 means that I think investors will pay up to 30X for that growth, which would put shares well over $200 in the next year, as they currently trade sub 25X.
 
But if we see a new trend of i-bank analysts re-thinking those estimates as they re-work their revenue and cost modeling, then I wouldn't hesitate to sell FB and look for less-controversial double-digit growth.

The Feds Drop a Bomb on Russian Interference via Facebook

Then the first heavy bomb dropped. I ended up taking profits of 30% on my last bunch of FB shares on the day the DOJ dropped their indictments on 13 Russians who attempted to interfere in our national election via social media. On February 16, I told my group...
 
"This to me spells more public and regulatory backlash against Facebook. And that uncertainty puts FB growth expectations in the crosshairs."

But after that dust settled, earnings estimates were still intact two weeks later, signifying confidence after the stellar Q4 outlook and report. Not a single i-bank lowered their growth projections.

This was my "tell" about how seriously the coming changes at Facebook would impact advertising revenues, beyond the mere noise in the news.

Yes, growth rates were slowing from the hey-days of 40-50%, but this year's projected 36% advance to $55 billion was still a marker of dominance in the digital advertising space even as the social giant voluntarily throttled its own ad volume.

A Self-Regulating Ecosystem?

You may have even noticed since last summer that the company has been aggressively attempting to stay one step ahead of regulators by forcing their own dramatic changes to policing ads and structuring the News Feed more around user social communities than unwanted ads.

In fact, FB had hired more than 10,000 new social media "cops" to do that work instead of relying on their failed algorithms. Even then, analysts were not lowering estimates on anticipated higher costs because the News Feed changes were anticipated to generate higher overall ad rates.

So we jumped back in FB shares on March 1 at $177 with a small starter position, ready for a trip to $160 to buy more if more fear should unfold. And I was feeling pretty good last week about the rally to new six-week highs above $186.

The Unknown Unknowns

Yet, I should have known better that more "unknown unknowns" could drop at any time.

Cambridge Analytica was that next bomb.

On Saturday March 17, The New York Times and The Observer reported on Cambridge Analytica's use of the personal information of potentially 50 million Facebook users without permission.

Appearing to react quickly, Facebook banned Cambridge Analytica from advertising on its platform and defended its conduct, but The Guardian reported that management had known about this security breach for two years and did nothing to protect its users. Shame on FB.

Shares gapped down 6% on Monday and fell further to $162 on Tuesday after a series of undercover investigative videos were released showing Cambridge Analytica's CEO Alexander Nix boasting about using prostitutes, bribery stings, and "honey traps" to discredit politicians whom it conducts opposition research on.

Nix also claimed that the company ran all of Donald Trump's digital campaign, including possible illegal activities. In response, UK investigators have asked for a warrant to search the company's servers.

At this point, Twitter (TWTR - Free Report) , which has seen a big boost in its ability to monetize the platform with advertising, could also be subject to investigations. I'm a daily user and see the "bots" working overtime to influence political opinion.

Headline Risk and Walking Back Price Targets... For Now

In an article this morning, Wall Street starts to trim Facebook targets as shares fall, Reuters reporters gathered opinions and moves from several i-bank analysts...

"We ... anticipate that the stock will be subject to further headline risk in the coming weeks as senior management is summoned to DC for hearings with lawmakers," Credit Suisse analyst Stephen Ju wrote in a note.

Many analysts have now raised concerns that the [Cambridge Analytica] incident will have a negative impact on user engagement with Facebook, potentially eating into its clout with advertisers. There are mixed views, however, on whether an aggressive regulatory response will materialize.

So far, U.S. and European lawmakers have demanded an explanation of how Cambridge Analytica gained access to user data in 2014 and why Facebook failed to inform its users, raising broader industry questions about consumer privacy.

Cowen and Co analyst Paul Gallant said that Congress is unlikely to act on the issue. He said that despite allegations of Russian interference, a bill requiring Internet companies to disclose foreign buyers of political advertising is going nowhere.

"We don't expect Congress to enact online privacy legislation anytime soon, even if Democrats win the House this fall," Gallant said.

(end of Reuters excerpt)

Systemic Peak?

Of course, there will always be analysts among the dozens that cover Facebook, who are calling for the demise of the social empire.

Pivotal Research Group analyst Brian Wieser reiterated his negative view Wednesday, writing that the social-networking giant is "exhibiting signs of systemic mismanagement"

"Investors now have to consider whether or not the company will conclude that it has grown in a manner that has proven to be untenable or whether it needs to significantly improve how it is managed," said Wieser.

Elsewhere, Scott Freeze of Sabretooth Advisors thinks the Cambridge Analytica scandal will speed up Facebook's demise and that the platform is destined to turn into MySpace.

"Any social media platform, in time, is going to become MySpace," said Freeze, who manages the New Tech and Media ETF (FNG - Free Report) . "Nobody young uses Facebook."

Facebook Finished, or Evolving?

This is the question: Does the platform have enough traction with billions of users (and growing) worldwide to maintain its digital advertising beachhead and successfully evolve in the new regulatory environment?

Here's what I told my group last night...

Today's news of the FTC investigating Facebook was a hammer blow that sent shares down to $162.
 
The volume was enormous at 129 million shares in the regular session and you have to go back to 2014 to find comparable volume days.
 
That means institutions were liquidating.
 
But some were also buying as the nice test of the lows saw shares bounce back above $168 in the last two hours.
 
So the answer to tonight's question is "Nope, Facebook isn't finished."
 
Sure, there could be Congressional action. And more public backlash.
 
But three things must be kept in mind I believe:
 
1) Past mistakes don't condemn the business model or its potential.
 
2) The company recognized problems over a year ago and has been fighting to prevent future abuses.
 
3) The premiere social networking/digital advertising business model will evolve to serve communities and commerce with better technology and more transparency, as well as new rules to protect people and their data.
 
All told, the damage was better than I expected, with shares only giving up 2.5%.
 
As tempting as it was to buy the lows under $165 today, I think we need to give it a few more days and see if anybody in Washington makes any big "national security" moves on FB.
 
Then we'll see where the analysts stand on the growth outlook and if we want to buy more shares in the $150's.

(end of last night's comments)

This morning, Wells Fargo analysts reminded investors not to forget about the success of Instagram with youth, despite the heated competition from Snapchat (SNAP - Free Report) .

Cooker's bottom line on FB today: I'm remain a Facebook investor and think the "evil dragon" image it has created for itself by letting algorithms do the thinking will create a platform evolution that makes this a company you will still be glad you owned 5 years from now.

Disclosure: I own FB shares for the Zacks TAZR Trader portfolio.

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