Hidden Layer: Pay No Attention To The Man Behind The Curtain — On Facebook

“Pay no attention to the man behind the curtain.” — Oscar Zoroaster Phadrig Isaac Norman Henkle Emmannuel Ambroise Diggs, a/k/a the Wizard of Oz, f/k/a “Oz, the Great & Terrible”

This phrase from the book “Wizard of Oz” came to mind after Facebook’s recent earnings report and conference call. The plot of the book resonates for my take on Facebook: A quartet of lost souls travel together in search of answers, with a little dog in tow, on a long winding path, for wisdom, bravery, a heart and finally a way home. They reached the end of the yellow brick road both enlightened and disillusioned about the answers they found ultimately.

Facebook’s shareholders and millions of users are now staring past the curtain. They came for answers, and just like in Oz, the results have not been as hoped for. Scott Galloway’s book, “The Four” explained in visceral terms the allure of “FANG” companies Facebook, Amazon, Netflix and Google. Based on the book, it might be said that Facebook grew by tapping into our inner Tin Men — our hearts — in exchange for our privacy.

Let’s review recent coverage to get a sense of what is behind the curtain.

From Techcrunch:

“Facebook’s chief legal officer Colin Stretch has announced he’ll be out by the end of the year.”

“Facebook has had a very awkward two years so far as politically charged scandals go. First revelations about the massive Kremlin-fueled election interference which it totally missed. Then the massive Cambridge Analytica data misuse debacle which Facebook also claims to have totally missed, even though it (still apparently) employs one of the academics whose quiz app was the vehicle used to suck out people’s data.”

“Since then a bunch of follow-on admissions have flowed from the company confirming that access to user data on its platform wasn’t as locked down as it’s historically liked to claim — albeit, despite masses of evidence to the contrary.”

“In March it also emerged that Facebook would likely be parting ways with its long-time chief security officer, Alex Stamos, this summer — after the New York Times reported on internal disagreements between the CSO and other execs, saying Stamos had wanted Facebook to be more public about the misuse of its platform by nation states.”

Regarding Stamos’ departure, Gizmodo noted:

“Facebook’s departing chief information security officer Alex Stamos, whose upcoming exit has been known for months, wrote a note to staff in March amid the Cambridge Analytica data-sharing scandal urging them to reconsider the site’s approach to privacy, BuzzFeed News reported on Tuesday.

“In his note titled “A Difficult Week,” Stamos wrote that the scandal — in which Facebook’s reckless approach to sharing data on users allowed the sketchy political firm to acquire data on somewhere around 87 million users — as well as others such as alleged Russian information warfare on the site were the result of “tens of thousands of small decisions made over the last decade.”

“When it rains…” From the Verge:

“Just one day after Facebook gained permission to open a subsidiary in China, the government pulled the business filing and began to censor mentions of the news. An anonymous source tells The New York Times that Facebook no longer has permission to launch the startup incubator it had planned.”

And the most recent quarterly earnings report was accompanied by double-digit after-hours decline in share prices, after closing above $217 per share before the report. A recap from Ars Technica:

“As part of its second quarter of 2018 earnings announcement on Wednesday, the company trumpeted a huge jump in both year-over-year revenue (42 percent) and profit (31 percent).”

“But there’s also been a notable slowdown in user growth.”

“During a call on Wednesday afternoon, Facebook CFO David Wehner warned that investors should expect a slower rise.”

“Our total revenue growth rate decelerated approximately 7 percentage points in Q2 compared to Q1,” he said.”

“Our total revenue growth rates will continue to decelerate in the second half of 2018, and we expect our revenue growth rates to decline by high single-digit percentages from prior quarters sequentially in both Q3 and Q4.”

CNBC report of the latest results included the following details :

• Earnings per share: $1.74 vs. $1.72 per a Thomson Reuters consensus estimate
• Revenue: $13.23 billion vs. $13.36 billion per a Thomson Reuters consensus estimate
• Global daily active users (DAUs): 1.47 billion vs. 1.49 billion, according to a StreetAccount and FactSet estimate
• North American DAUs: 185 million vs. 185.4 million, according to a FactSet estimate
• European DAUs: 279 million vs. 279.4 million, according to a FactSet estimate
• Average revenue per user (ARPU): $5.97 vs. $5.95, according to a StreetAccount and FactSet estimate

“Facebook said 2.5 billion people were using any of its family of apps each month, including Instagram and WhatsApp. Though Facebook-specific global DAU rates were up 11 percent year over year — with growth led through users in India, Indonesia and the Philippines — it was less than Wall Street was projecting.”

“Wehner also said the company expects margin compression, with operating margins trending toward “mid-30s on a percentage basis,” compared with second-quarter operating margins of 44 percent.”

“That tightening is the result of broadening markets, investments in news products — such as the recent introduction of the company’s long-form video format, IGTV — and capital expenditures related to safety and security that total “billions of dollars,” Wehner said.”

A drop in European Daily Average Users (DAU) was expected in the wake of the General Data Protection Regulation (GDPR). While the earnings impact was not material as of this latest report, management acknowledged that it was still early days regarding GDPR. Increased expenses for both new products and safety help to explain an anticipated drop in margins from the 40s to the 30s.

Stamos, leaving in August, may have inadvertently summarized in his March 23 memo what Facebook is doing: “We need to deprioritize short-term growth and revenue and to explain to Wall Street why that is ok.”

Closing thoughts (written in fact a few months ago as my initial reaction to events surrounding Cambridge Analytica): Recent performance of “FANG”-related shares in the market may invite growing regulatory response to their economic and information dominance. I wonder if what had happened to Standard Oil, AT&T, I.B.M. and Microsoft would be followed with more of the same for one of the “FANGs”? In addition to punitive fees and increased restrictions, could there perhaps be “breakups”, as had happened to Standard Oil and AT&T? (Baby FANGs someday?)

All eyes have all fallen upon Facebook as the curtain has been pulled open on the FANG nearest and dearest to our hearts.

(Earnings report summary from investment firm Avory & Company, and the most recent weekly chart for Facebook. As of this writing, this evening after the earnings conference call, after-hour share prices are in the 170s, after briefly touching the 160s per share.)

Originally published at big-stack.com on July 26, 2018.