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4 Reasons to Sell Facebook Stock Near the Lows

Vince Martin

The fundamental case for Facebook (NASDAQ:FB) looks close to absurd at this point. Facebook stock trades at barely 19x earnings. Back out some $14 per share in cash, and the price-earnings multiple assigned to FB stock gets closer to 17x. For a tech giant expected to grow revenue 24% next year, that multiple seems absurd.

Yes, spending is going to rise next year, hitting earnings. Guidance for that spend led Facebook stock to the largest one-day loss in stock market history back in August. But spending will normalize going forward, meaning Facebook should get back to growth as soon as 2020. Yet, a 17x ex-cash multiple suggests hardly any growth is priced in at this point.

Despite the attractive numbers, however, there are reasons to sell Facebook stock. And those reasons are mounting. Facebook continues to run into problems and Mark Zuckerberg & Co. continue to manage those problems poorly. At some point, the risk here is that Facebook is going to turn off users, and not just investors.

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If that happens, even a price that is threatening a 22-month low won’t be cheap enough, or close.


The “Never One Cockroach” Problem for Facebook Stock

As Warren Buffett put it regarding scandal-plagued Wells Fargo (NYSE:WFC), “What you find is there’s never just one cockroach in the kitchen when you start looking around.” That old investing saw has been proven yet again when it comes to Facebook stock.

For most of 2018, there’s been a steady drip of negative news. It started with the Cambridge Analytica scandal in March. FB stock bounced back quickly from those declines before the post-Q2 earnings plunge. But even then, bad news was starting to build up. WhatsApp founder Jan Koum departed, reportedly over privacy issues. In June, the Wall Street Journal reported that Facebook gave developers access to user data after it had insisted otherwise. The paper disclosed an SEC probe the following month. At the same time, concerns about the platform’s use in lynchings in India and violence in Myanmar began to rise.

The company itself disclosed a security issue in September. In November, as Larry Ramer pointed out, the New York Times reported that COO Sheryl Sandberg had tried to keep Russian misinformation efforts quiet – and that a Facebook-hired lobbying firm had tried to tie Facebook opponents to billionaire activist (and target of right-wing disdain) George Soros.

Now, the company is being sued by the District of Columbia. And the Times is reporting that the company gave away much more data than it disclosed to partners including Microsoft (NASDAQ:MSFT), Amazon.com (NASDAQ:AMZN), and Netflix (NASDAQ:NFLX). FB stock is down nearly 5% on the news.

Can we be sure that no more bad news is on the way? And do investors really want to wake up every morning waiting for the next shoe to drop – and for Facebook stock to do the same?


The Management Problem for FB Stock

Facebook admittedly has had more than its share of problems of late. But it’s also done a terrible job responding to those problems. The company increasingly seems tone-deaf and authoritarian. Sandberg hemmed and hawed her way through the Soros scandal. She first denied any knowledge that the company had hired lobbying firm Definers. The Facebook COO then acknowledged that “some of their work was incorporated into materials presented to me and I received a small number of emails where Definers was referenced” – in a post that the company tried to bury by releasing it on the day before Thanksgiving.

CEO Mark Zuckerberg seems to alternate between saying the problems aren’t that big, will be fixed, have to be fixed, or already have been fixed. A post from another Facebook executive in regard to Wednesday’s Times story insisted that no data was released without users’ permission – then pointed out that most of the features were shut down anyway, while the company is “already in the process of reviewing all our APIs”. Which is it? Does anyone trust that response at this point?

There’s simply a constant perception here that Facebook has something to hide. There’s a consistent response of “delay, deny, and deflect,” as the Times put it. Even beyond that, there’s a sense that Facebook can’t even control itself. Why are privacy issues only being reviewed in 2018? Why was data privacy not a greater focus in the past?

Even giving the company the benefit of the doubt, it repeatedly seems like Facebook itself is surprised to see all the ways in which its data can be abused. That further erodes confidence in management at this point.


Will Users Leave?

The risk in the near- to mid-term is that users will stop giving Facebook the benefit of the doubt. The story of Facebook stock can’t be separated from the story of Facebook users, as I wrote in April. The #DeleteFacebook movement fizzled out, admittedly. And user growth has been stable, if slowing (that’s hardly surprising given the sheer size of the user base).

But bad news and clumsy responses are going to affect Facebook’s brand image. And once defections start, they may not stop. Facebook is the classic beneficiary of the “network effect”: each incremental user adds to the experience and value of the existing base. It’s fun to go to Facebook because everyone is on Facebook.

That effect works in reverse as well. Users now have multiple reasons to leave the platform – or at least limit their usage. Some may not want to further line Zuckerberg’s already full pockets. Others may see too much privacy risk. For some (myself included), the sheen has worn off.

This isn’t to say that Facebook necessarily is the next Myspace. WhatsApp and Instagram can cushion any weakness in the namesake platform. But even at 17x earnings, user declines probably aren’t priced in.


Are Regulators Coming?

Big tech firms are seeing increased political risk – and Facebook probably faces the most at the moment. It’s alienated liberals by attacking Soros and allowing Russian disinformation to spread. Conservatives believe the platform, and the company, have an intrinsic left-wing bias. Facebook probably doesn’t have many allies in Congress – or the White House.

I’m skeptical a legally-forced breakup of Facebook is on the way. But stranger things have happened. At the least, Facebook already is facing increasing regulation around privacy in Europe. U.S. regulators and legislators could follow.

And because of its missteps of late, Facebook has put itself in the crosshairs. Zuckerberg just a few years ago appeared a wholesome American success story. He now looks like a villain in many citizens’ eyes. As such, politicians can score points attacking Facebook now. The more bad news that gets released, the higher those scores go.

The broad point is that the bad news for Facebook likely isn’t over. And the effects of that bad news are unclear. At the least, the risks to Facebook stock from user fatigue and political action are rising. As long as that continues, FB stock will stay stuck at best.

As of this writing, Vince Martin has no positions in any securities mentioned.

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