At Facebook, Scandals and Slowing Growth Made for a Rocky 2018
By almost any measure, 2018 has been a terrible year for Facebook (NASDAQ: FB). The company's image has been hammered by scandals including Cambridge Analytica's unauthorized use of user data, the use of the platform to spark a genocide of Rohingya Muslims in Myanmar, the aftermath of Russian interference in the 2016 U.S. presidential election, and, most recently, revelations that Facebook hired an opposition research firm to tie its opponents to George Soros and even accuse them of anti-Semitism. The result of the near-constant negative attention is that users, activists, and even legislators are questioning whether Facebook is a net positive for democracy, and many are demanding increased regulation and oversight of the social network.
On the business side, the company faced challenges as user growth plateaued in its core markets in North America in Europe, and management said margins would narrow as it invested in additional employees and tech tools to help restore user trust in the platform and better serve its mission of connecting people in a positive way. The slowing growth and rising costs, along with the brand image problems, weighed on the stock, pushing shares down more than 20% for the year.
A maturing company and questions about the future
Facebook's daily active user (DAU) base continued to grow in developing markets like Asia-Pacific, Latin America, the Middle East, and Africa, where the social network added more than 100 million DAUs over the last year. In North America and Europe, however, markets where the company makes the vast majority of its profits through advertising, daily user growth plateaued. Adjusted daily user growth in North America was up just 1 million to 186 million over the past year, while in Europe, the company added 10 million accounts on an adjusted basis, reaching 284 million.
It's unclear whether the company's slowing user growth is simply a function of it maturing, as it's already reached much of the total addressable market in North America and Europe, or if there's a substantial backlash against the platform from the bad news that has surrounded it. Facebook doesn't report "churn," or the number of users who leave the platform, but according to the Pew Research Center, a significant percentage of users are checking the app less frequently.
Facebook plans to hire and spend aggressively over the next year, which would slow earnings growth. On multiple occasions, management said it would step up investments in security and privacy, and headcount is now growing faster than revenue -- 45% against 33% top-line growth in the most recent quarter.
The company also warned that revenue growth would slow, as growth in the business comes from lower-monetizing geographic regions and products such as Stories. In fact, the stock plunged 19% in one day following the company's second-quarter earnings call, during which management said its operating margin would fall over the coming quarters due to those investments in the shift in its growth. That's trending toward the mid-30s over the long term, down from 47% over the last four quarters. Facebook also said it aims to de-emphasize viral videos and third-party news, which could be weighing on earnings growth as well, though those changes are part of the company's efforts to prioritize meaningful connections between users.
Scandals, scandals, and more scandals
It's hard to understate the negative publicity surrounding Facebook this year and the vitriol it has received in response. The company came into 2018 with a damaged reputation, and concerns about abuse, hate speech and privacy have only snowballed.
Perhaps the worst scandal Facebook faced this year came in March when news broke that data consulting firm Cambridge Analytica used Facebook data on behalf of the Trump campaign to target and influence voters in the U.S., which violated the social network's rules. Facebook shares sold off sharply in response to those revelations, as they seemed to confirm beliefs that Facebook was unable to protect user data. The furor led to a whole new round of protests against the stock, sparking a #DeleteFacebook campaign at one point.
In what has become a pattern, Facebook struggled to respond to the reports, initially underestimating the level of anger. The company apologized, and CEO Mark Zuckerberg promised to do better, but he remained on the hot seat. Zuckerberg went before Congress weeks later to answer questions from legislators and defended the company effectively, acquitting himself well in the process. The stock rose in response and surged through a strong first-quarter earnings report at the end of April.
The drumbeat of bad news around Facebook never really disappeared, though. In announcing their departures from the company, WhatsApp's co-founders exposed a rift over privacy issues. Then Instagram's co-founders departed Facebook because of the photo-sharing app's decreasing independence.
In November, a New York Times report exposed a series of underhanded tactics Facebook used to defend itself while in the midst of turmoil and portrayed a management team that often seemed power hungry and lacking a moral compass. As a result of the string of bad news, employee morale has steadily fallen, according to Glassdoor and news reports, and the company's reputation has been significantly damaged, which could jeopardize Facebook's ability to recruit new hires. Facebook also lost its title as Glassdoor's Best Place to Work.
Not all bad news
Though 2018 was clearly a challenging year for the company, there are a couple of reasons for investors to take heart in Facebook's future. The network and the business continue to grow briskly despite the parade of scandals, user backlash, and substantial negative press. Even in its mature markets, Facebook's user base is still growing. If users are leaving the platform, new ones are coming in faster than the old ones are going out. Advertisers have, so far, proved willing to stick with Facebook regardless of concerns about the platform's effect on society at large and are likely to continue to spend on Facebook as long as the eyeballs are there.
Facebook's struggles have not translated into user gains for social media rivals like Twitter and Snap either, meaning its dominance of the industry continues.
Finally, Instagram remains a juggernaut. The photo-sharing app that Facebook acquired in 2012 for just $1 billion reached 1 billion monthly users in June, and growth on the platform seems to be accelerating. Instagram has escaped much of the negative publicity that's hounded Facebook this year, and many users who have balked at Facebook have simply shifted their attention to the photo-sharing app. Instagram has helped Facebook capture younger consumers, who are increasingly avoiding the largest social network in favor of photo-based alternatives. Although Facebook doesn't break out Instagram's financials, it's clear that the app has tremendous potential if it's not already contributing meaningfully to Facebook's bottom line.
The past year may have brought Facebook down, but it's certainly not out. Investors will likely need to get to used to slower growth, but Facebook is making investments and responding, albeit slowly, to concerns about privacy and other issues on the platform. Those moves should help better ensure the company's long-term success.
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Jeremy Bowman owns shares of Facebook. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool recommends The New York Times. The Motley Fool has a disclosure policy.