In this segment from the Motley Fool Money podcast, host Chris Hill is joined by Jason Moser of Million Dollar Portfolio, David Kretzmann of Hidden Gems Canada, and Aaron Bush of Motley Fool Rule Breakers to discuss Facebook's (NASDAQ: FB) "apology tour" as CEO Mark Zuckerberg geared up to give testimony on Capitol Hill. The social network's executives have been fanning across media outlets to apologize for the company's role in the recent Cambridge Analytica scandal. The team thinks management is taking responsibility -- it's already changing some of the APIs -- but it's unclear how much the changes will affect profitability.
A full transcript follows the video.
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This video was recorded on April 6, 2018.
Chris Hill: For the second week in a row, we begin with the ongoing saga at Facebook. Next week, CEO Mark Zuckerberg heads to Capitol Hill to testify before House and Senate committees. This week, Mark Zuckerberg and Chief Operating Officer Sheryl Sandberg embarked on what The Wall Street Journal has called the Facebook Apology Tour, saying all the usual things, David. Mistakes were made. This feels like one of those situations where it's going to get worse before it gets better.
David Kretzmann: Well, as a Facebook shareholder, I certainly hope not. I feel like all of this is a precursor to Zuckerberg testifying before Congress next week. That's really what everyone is waiting for. I think, if you're Zuckerberg and if you're Facebook, you're just hoping to get through that testifying, testification, whatever you call that.
Hill: Testimony, I believe.
Kretzmann: Testimony, that's it, that's the word I was looking for. You're trying to get through all that without starting any more fires or flaming up these fires any more than they already are there. I like what Zuckerberg and Sandberg are doing here, taking responsibility, saying that they made a mistake, they need to do more to control what third-party developers and apps are doing as far as access to user data. So, I think they're on the right track, but it could get a little bit uglier in the short-term.
Aaron Bush: We're already seeing them take some steps to reducing the extent to which their data can be accessed by third parties. A lot of their APIs have already been shut down or changed. I have a feeling we'll probably see stricter and stricter data policies going forward. What's interesting about this though is that it might actually be a good thing for Facebook. It's bad in the sense that it takes away any ambitions they had about becoming a broader platform, getting into transactions and payments and things like that. But, they already have a pretty huge walled garden, and these changes just make those walls rise up even faster.
Jason Moser: I think Aaron brings up really the key point. We have to separate ourselves and look at this from the human perspective and the investor perspective. Not to say that we investors aren't humans, but I think sometimes people think we may be a little bit more heartless than others. I think really, for me, yeah, I agree with you. I think this ultimately works out well for Facebook in that they're going to be the ones with the data. This gives them the upper hand. This gives them the power. And advertising is not going away, so I could see a world where this actually works out well for them.
It remains to be seen how many people actually follow through with that commitment of shutting down their Facebook account. But favorite is that, "I'm going to shut down my Facebook account. You can find me on Instagram." I mean, let's be clear, Instagram is owned by Facebook, so that really works out well for them. And I think we will see, as time goes on, Instagram become a bigger part of that revenue stream. The breakdown today, right now, Facebook has about six million advertising partners versus Instagram's two million. There's obviously going to be a lot of overlap there. But I think it's time goes on, we'll see more of those advertising partners moving over to Instagram, which will work out well for Facebook. Let's also remember they own WhatsApp, they broke out Messenger.
I'm not giving Facebook a pass here. I don't own Facebook shares, I don't think I ever will, I don't really like the platforms, I'm not a big fan of the company, but, you have to look at facts here, and this is a huge business with a huge user base. And at the end of the day, I think a lot of people out there that use Facebook are going to say, "Where else am I going to go?"
Kretzmann: I think there's actually an argument to be made that most of the negativity is already priced into the stock, and then some. Right now, Facebook, as of the latest quarter, was growing twice as fast as Alphabet or Google. They're far more profitable than Alphabet, but right now their valuation is lower than Alphabet's. So, I think a lot of this pessimism is already priced in. That's why I think, looking out over the next three to five years, the stock handily outperforms the market from here.
Hill: I'm glad you mentioned the profitability, because one of the things Sheryl Sandberg was very clear about this week was that profitability will be impacted. And I don't know, they report earnings in about a month or so. And maybe not so much is going to show up in this quarter, but I sort of feel like yes, this might be a buying opportunity, this might also be the opportunity where six months from now, we look and say, "Wow, we didn't realize just how much the profitability was going to be impacted."
Moser: We've got examples here in the recent past of companies where we felt like it was a bad situation, but surely it would get better. Under Armour and Chipotle are two easy ones.
Hill: Oh, sure, take two stocks that I own. [laughs]
Moser: And I own those, too, myself, Chris, so, I'm feeling your pain. There was an interesting idea I've seen kicked around here and there, that perhaps you could charge users for Facebook in exchange for not sharing their data. I think that would be an interesting pilot to attempt. I don't know how many people ultimately care about that to the degree that they would pay. I think the bigger problem, though, is that the toothpaste is already out of the tube, as they say here. Would people actually trust them? If Facebook tells me, "You can pay Facebook and we won't share your data," do I actually believe you're not sharing it? And right now, no, I personally wouldn't trust them. Now, over time, perhaps they gain that trust back. But that's a big hurdle to clear here in the near term.
Bush: To me, the largest risk right now is that the regulatory snowball continues to get bigger. Testifying in front of Congress, that's going to be maybe peak volatility and movement, depending on how well Zuckerberg does here. But, politicians in the U.S. and Europe are pretty angsty, and to what extent they can change laws that might even restrict Facebook's own access to their own user data, I think that could be pretty influential. But a lot of this is just how people in general perceive it, because they only are the sum of their users. Even though lock-in seems pretty high because everybody uses it, switching costs are actually pretty low, because you could just stop using it.
Moser: I remember back in the day, during the middle of the financial crisis, and Hank Paulson would get up there and give a press release, and the market was either up 500 points or down 1,000. I don't know that we'll see that volatility with Zuckerberg testifying. But, yeah, I can't imagine a situation where he comes across very well. [laughs]
Kretzmann: Yeah, we'll see. So far, over the past week, Zuckerberg and Sandberg have said that they haven't really seen much of an impact on revenue or users dropping off the platform. But, even if they do take a hit over the next six months or the rest of this year, this is a company that, in the last quarter, grew revenue around 48%. Profit margin is still close to 40%. Google's profit margin is in the low 20s. So, they can afford to take a hit and slow down revenue growth, and even take that hit to profitability. I think the stock is still compelling today.
Hill: Although, Aaron, you were saying before we started taping, that depending on the geography of people dropping off of Facebook, it can have a bigger effect.
Bush: Yeah. Users in the U.S. and Europe, those are monetized at significantly higher rates than the rest of the world. So, even if we do see just 1% of users drop off, if those happen to be from the U.S. or Europe, where people are worried more about privacy, it could have a larger than 1% impact on the business.
Moser: Yeah. And just one final point here, we kicked this around in MDP for a while, we ended up selling just a little bit of our Facebook position, and the logic there was what Aaron chimed in a little bit earlier, the optionality factor. That's just gone in the near-term. We're not going to see payments, we're not going to see commerce. Those are going to be off the table, I think, for Facebook, for at least a little while.
Hill: So, if those are off the table, does this increase the likelihood that Facebook moves further down the line toward some sort of programming? Whether it's original programming, movies, or live sports?
Kretzmann: I think you could see some of that as ways to bolster the platforms that they do have. I think it could also potentially be a boon for the company. If they can't rely on acquiring talent, maybe they have to do a little bit more R&D internally and have some more homegrown development of new platforms. I mean, the company's sitting on, what, over $40 billion of cash, no debt. I think we could also see them repurchase a good amount of shares if the stock does stay at these lower levels or goes down even further. Hey, maybe even a dividend. A lot to do with that cash.
Bush: I think Facebook 2.0 is just going to be them in income mode, where they're no longer the upstarts that are trying all these new things. They're now in the business of protecting their territory. So, if that means paying for new content, that's not the greatest business model, but things like that, if that's what retains users, they will do and sacrifice some profitability for it.
Hill: Jason, you get the last word.
Moser: Time for Facebook to grow up.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Aaron Bush owns shares of Alphabet (C shares), Chipotle Mexican Grill, Facebook, Under Armour (A Shares), and Under Armour (C Shares). Chris Hill owns shares of Under Armour (A Shares) and Under Armour (C Shares). David Kretzmann owns shares of Alphabet (C shares), Chipotle Mexican Grill, Facebook, Under Armour (A Shares), and Under Armour (C Shares). Jason Moser owns shares of Chipotle Mexican Grill, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Chipotle Mexican Grill, Facebook, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has a disclosure policy.