Where Will Facebook Go From Here?

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In this episode of MarketFoolery, host Mac Greer talks with Motley Fool contributors David Kretzmann from Hidden Gem Canada and Ron Gross from Total Income about news out of Facebook (NASDAQ: FB) and Guess (NYSE: GES). Mark Zuckerberg finally broke the silence around the Cambridge Analytica data breach situation and made some interesting comments about potential regulation in Facebook's future.

How worried should Facebook investors be about decreasing user engagement in the wake of this scandal and as fewer young people are reportedly using the platform? Also, shares of Guess are up a whopping 25% on better-than-expected earnings. But the company still has some significant concerns going forward, and is no stranger to volatility. Find out more on MarketFoolery.

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A full transcript follows the video.

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This video was recorded on March 22, 2018.

Mac Greer: It's Thursday, March 22nd. Welcome to MarketFoolery! I'm Mac Greer, and joining me in studio, we have Ron Gross from Motley Fool Total Income and David Kretzmann from Motley Fool Hidden Gems Canada. Gentlemen, welcome!

David Kretzmann: Hey, Mac!

Ron Gross: Hey, Mac! How are you?

Greer: I'm good. We have a lot of good stories we're going to talk about. I say "a lot." We have two good stories.

Gross: [laughs] Two has never been defined as "a lot."

Greer: That's true.

Kretzmann: Until now.

Gross: It's not even a few.

Greer: There's a lot of meat here, though. We're going to talk Guess a little later. Guess is the high fashion apparel company, Ron?

Gross: I don't know if I would call it that.

Greer: Did you ever go through a Guess stage?

Gross: Sasoon and Jordache were my speed, but I don't really get into it.

Kretzmann: Back in the hedge fund days, right?

Gross: [laughs] Oh, yeah, right.

Greer: Well, a great day for Guess in the wake of their earnings, so we'll talk some Guess. But guys, we're going to begin with the story that just keeps giving, Facebook, and Mark Zuckerberg finally breaking his silence about the controversy surrounding Cambridge Analytica, the data firm that accessed information from 50 million Facebook users without their knowledge. That's the key part, right? Didn't know what was happening there.

Now, on yesterday's MarketFoolery, Chris and Tim talked Facebook, but that was before the Zuckerberg apology tour really cranked up, guys. So, I want to talk about the interviews he did yesterday and get your reaction. He did apologize. He said Facebook made mistakes. He called the Cambridge Analytica situation "a major breach of trust." He said Facebook would crack down on outside apps and bolster privacy, and he told multiple outlets that he would be willing to testify before Congress. That all sounds great. He said the company would notify everyone whose data was improperly used. There's a lot there, David. What was your reaction?

Kretzmann: Probably the most surprising thing to me was his response to the question, "Why shouldn't you be regulated?" He was basically saying, "No, actually, I think we should be regulated," something along those lines. I thought, that's probably a mature response, shows that he's not the rebellious college kid in the dorm room trying to disrupt everything and break things. But to me, it also raises the question, why do you need to wait for regulation to happen to bring more transparency to the advertising happening on Facebook's platform? In general, I thought it was a good start for him to finally make a public apology, explain a little bit of what's going on. I don't know why it took them several days to get to that point. But all in all, a good start. It makes me a little more confident that this is something that Facebook can get behind it and move ahead of this story.

Gross: Yeah. I'm probably in a forgiving mood this week. I'm not piling on Facebook and Zuckerberg. I think this actually isn't a Facebook problem, it's a technology data privacy problem that was bound to happen, and it has been happening over the last few years with many, many companies and data breaches and improperly using data. Even back in 2014, Facebook took steps to improve this. A lot of this stuff that went on happened in 2013. It's not like Facebook has been sitting on its hands. But, agreed that they need to do more. Zuckerberg is not an out-in-front-of-the-camera kind of guy, but I thought he was sincere. And I think he had to do that interview and it was appropriate, and I do think he needs to go in front of Congress if need be, for sure.

But, I think all companies are going to have to figure out how to protect our data better. As David said, this is a story about regulation, and is regulation necessary. Companies need to police themselves. But, probably, some regulation is going to be necessary. Then, there's implications for censorship, free speech, competitive business implications, because regulation always has a downside, even though sometimes it's necessary.

Greer: So, there's now a delete Facebook movement. And Zuckerberg mentioned that in some of the interviews, saying he didn't see it as a big threat. He said that it's not good, though. Should investors be worried?

Kretzmann: Not yet. I don't think this will have far-reaching implications. If there were more stories that came out that there were more data breaches, or cases where Facebook was underestimating the impact of this, then maybe. But at this point, Facebook is increasingly a global story. So, even if you're seeing engagement level off or drop a bit, I would expect primarily in the U.S. -- first of all, I don't think that's going to happen. But even if it did, I don't think it's something that'll be anything more than a short-term impact, because the network effect here is just so sticky. If you're already on Facebook, that's the way that you'll often connect with family, friends, share photos, stay connected with your group. And even if you delete Facebook today, I wouldn't be surprised if in six months or a year from now, if there's not a better alternative that pops up, you end up going back to Facebook.

Greer: Let's talk about that, David, because one of the stories we hear is this research showing that younger people aren't as big on Facebook anymore, younger people are leaving Facebook. As our resident younger person -- sorry, Ron -- but, as our resident millennial, what do you think about that? If younger people leave Facebook, where do they go?

Kretzmann: I think at this point, at least in the U.S., you're primarily going to Instagram and/ or Snapchat (NYSE: SNAP). It really just depends what you're trying to do. If you're trying to message friends, Snapchat is probably the go-to platform. But if you're trying to have the broad reach sharing pictures and videos, you go to Instagram. I don't think there's any doubt about that.

Greer: Which is owned by Facebook.

Kretzmann: Right.

Greer: So, you're leaving Facebook and you're going to Facebook.

Kretzmann: Pretty much. That narrative has been played out for probably almost five years now, that young people are leaving Facebook. And to an extent, it's true. They might be taking a longer time to start accounts. But, I think as young people get older and want to connect with parents and grandparents and the rest of their friends as they're getting older and starting to have families, you're probably going to open up a Facebook account at some point. In the meantime, you're probably going to have Instagram and possibly Snapchat. It's not necessarily a zero-sum game here. So, that narrative is not new. And even with people bringing that up again and again, it hasn't really dented Facebook's results at all.

Gross: From an investor perspective, I'm not concerned about the business model. In fact, I'm looking forward to seeing how this continues to evolve. I think they'll continue to produce gobs of free cash flow as a result. I think it's mostly from an investor perspective, it's about management and communication. If you see the company not handling this well and not communicating this well, then the market is going to turn sour on them and could stay sour for long periods of time, even if you're a long-term investor. So, this is where Zuckerberg needs to step up, make changes if necessary, communicate when necessary. We've seen lots of data breached companies not do a good job and really pay the price from a stock perspective. So, that's what I'm going to keep an eye on.

Greer: David, what's one thing you're watching going forward here?

Kretzmann: For me, the biggest question marks are probably regulation, both here in the U.S. and how Facebook can respond to that or ideally get in front of that, but also the implications for Facebook's global growth. Will more countries go the route, like China did, of basically saying, "You can't operate here"? If more governments and countries basically decide, "We probably have more to lose than to gain by allowing Facebook to operate here. Let's support a home-grown social network instead," that could really limit Facebook's growth opportunities.

But, what I would really like to see from Facebook, and this was something that Zuckerberg mentioned in the CNN interview, basically saying that advertising on TV platforms has a lot more transparency. You know who's buying the ads, and you can get all of that info. He was saying, we probably need regulation on Facebook to have more transparency to see who's paying for ads and basically what's behind the ads that you're seeing on Facebook. I don't know why you need to wait for regulations to start moving in that direction. I think with any ad on Facebook, you should be able to click and see how you got targeted to that particular ad, who paid for it. I'd just like to see them move in that direction, even if regulation takes a while to get there.

Gross: I'm looking forward to seeing if I'm one of the 50 million whose data was breached, because then, out there, someone will know my birthday and that I like pizza. And that could be devastating.

Kretzmann: Absolutely.

Greer: Oh, my gosh! It makes me shudder what they're going to think of me. It's like, "This guy talks about Costco a lot." OK, we will keep an eye on it.

Guys, for a second story, I want to talk Guess. Shares of the apparel retail juggernaut -- At least for today. At least for today. Shares of Guess up 25% on better than expected earnings. Ron, apparently there are places besides Costco that sell apparel?

Gross: There are?

Kretzmann: [laughs] That's news.

Gross: Well, you know what, that place happens to be overseas in this particular case, because that's really where Guess is getting it done. Over the years, it has become an overseas story. Sales growth in Asia and Europe this quarter, 40% for Guess, which is really impressive. And the stock being up 20-25% on that news, there must have been some pretty low expectations built in, because that's a big move. Sales in the Americas do continue to be weak, and that's been an ongoing struggle for them, down about 6%. I think they're going to continue to struggle.

But, they're committed to still throwing capital overseas. They think they'll grow sales double digits, they'll expand margins there. Guidance going forward was really strong. They'll probably do about $0.80 per share in the coming year. They've actually returned a ton of cash to stockholders in the form of stock buybacks, just two million shares alone in the latest quarter, plus dividends. I want to say the dividend is a 6% yield, I think, on this bad boy, which is a big number. And the stock is now up 65-70% on the year. So, this sleepy little retail apparel company who had been struggling for a while has turned the corner.

Greer: But when you pull back and look at the stock chart, Ron, it's been incredibly volatile. A great last year, as you just mentioned, but they've really lost big to the market over the last five years. And if you've held the stock for the last five years, you've lost money. This stock has been all over the place.

Gross: All over the place. And even, at this point, with these great numbers we're talking about, I'm not sure I'm a buyer. Based on forward earnings guidance, I want to say 22X earnings, probably, for a company that I think will continue to struggle in the Americas and will probably come up in a couple of years on slowing growth overseas as well. It's not expensive, but it's probably not a stock that I would care to own.

Kretzmann: Yeah. What stuck out to me, the weaknesses in the Americas is something that we're seeing and a lot of apparel companies. But to me, the fact that their retail sales were down even when you include their e-commerce operations, that just doesn't seem very good. This just doesn't strike me as a best in breed apparel company. I think there are a lot of better options trading at similar or possibly even better valuations, just considering the overall strength of the business and prospects for the business. But, they're not going to disappear or anything like that. They have a healthy balance sheet. Over $300 million in cash. Free cash flow is now positive again. But it's been a rough journey.

Something that did stick out to me as well is the co-founder is still with the company. He's heading it up as CEO, and I think he owns something like 15-16% of the company. So, you have a founder with a lot of skin in the game, healthy balance sheet, looks like some strong international growth. So, there are reasons to think that maybe their worst days are behind them. But, still not a story that really appeals to me.

Gross: So, I thought the co-founder, after the Kate Upton accusations, had relinquished his duties. Are you maybe speaking about the other co-founder?

Kretzmann: Co-founder means there's more than one, right?

Gross: Right. I think Paul Marciano has been forced to step away. I don't know if this will necessarily impact the company from an investing perspective in the longer-term, but there's certainly a little pall that hangs over.

Kretzmann: Yes, I'm seeing that he's on a leave of absence now. Scandalous.

Greer: Normally to wrap up this show, I would ask you my famous desert island arbitrary question, Guess vs. Facebook over the next five years. Is it fair to say we're all Facebook?

Gross: Yes.

Kretzmann: Yeah, I think so.

Greer: OK, so I'm not going to ask you that. But, in the spirit of Guess, I am going to ask you, looking back over your life for your most questionable fashion decision, something that, when you wore it, you thought, "Wow, I'm really rocking this!" And you look back and you're like, "That was probably a mistake." I'll give you time to think about it. I'll tell you, when I was in elementary school, I owned green toughskins and I had a long-sleeved green silk shirt with a scene from the Amazon. And I tucked it in and I had a big Coca-Cola belt buckle. And I thought I was on fire. In hindsight, I'm just not sure I was all that.

Kretzmann: Not quite there.

Gross: I'm sad to say there's so many I could choose from that we could almost do a whole other segment on my fashion faux pas. I'm going to go with what I thought was a really sweet long sleeved black shirt with zippers all over the place.

Greer: Zippers. Wow!

Gross: I thought it was so cool. I want to say it was purchased from Merry-Go-Round. If you're from Jersey or New York, you might know about Merry-Go-Round. And I was so happy about it, and I walked into school and everyone started calling me Michael Jackson. And I was like, "Wow! I think maybe I missed the boat here."

Kretzmann: Worth a shot.

Greer: David?

Kretzmann: I don't know if it counts as fashion, but hairstyle, can we throw that into the fashion category?

Greer: Yes.

Kretzmann: When I was a teenager in high school, two separate occasions I bleached my hair by myself with hydrogen peroxide.

Greer: Oh my gosh!

Kretzmann: Going through the rebellious Eminem stage. Like, why not, I'll bring up Slim Shady here.

Greer: And were you pleased with the look?

Kretzmann: Hey, I rocked it twice, so obviously some of the gears in my head thought it was a good idea. But, eh, a little regrettable.

Gross: I did sun and it turned my hair orange one summer.

Greer: I had friends do this in the early 2000s, I need someone who will basically do a fashion intervention, because I didn't get the memo when pleated pants went out.

Gross: Oh, yeah. Sure. Of course.

Greer: And they went out, I think, in the 90s, and I wore them into the 2000s. So, I wore them 10 years too long, along with a braided belt. Do you remember the leather braided belt?

Gross: Oh, God, yes!

Greer: And finally, I had a few friends, and it was like an intervention. They're like, "You have to quit wearing the pleated pants."

Gross: That's great. Do you still wear acid washed jeans, too? Although, I think those are coming back, probably.

Kretzmann: Oh, yeah, he's rocking them.

Greer: I have them on right now. They're stonewash, not acid. Come on, please. Show some respect!

Gross: Sorry, sorry!

Greer: OK, guys, thanks for joining me!

Kretzmann: Thanks!

Gross: Thanks, Mac!

Greer: As always, people on the show may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of MarketFoolery. The show is mixed by Austin Morgan. I'm Mac Greer. Thanks for listening! We'll see you tomorrow!

David Kretzmann owns shares of Costco Wholesale and Facebook. Mac Greer owns shares of Costco Wholesale and Facebook. Ron Gross owns shares of Costco Wholesale and Facebook. The Motley Fool owns shares of and recommends Facebook. The Motley Fool is short shares of Guess. The Motley Fool recommends Costco Wholesale and Guess. The Motley Fool has a disclosure policy.