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  • KPB & Co Research

During the conference call in the second quarter of the fiscal year 2018 - (Q2 of FY-18), the management at Facebook, (NYSE:FB) led by Mark Zuckerberg, outlined plans to revise the company's expected earnings and revenue trajectory downward. The downward revision reflects primarily a rise in operating cost, and a slowdown in business momentum as the regulatory environment got increasingly hostile. The company has had to hire more people to deal with data privacy concerns, and slow business momentum as more resources were diverted towards meeting regulatory hurdles.

New Growth Avenues

As Facebook came under more scrutiny over the handling of personal data, and fears around election manipulation, the company increased their workforce by over 40% to strengthen their capability to handle filtering high traffic user posts, and user privacy. Higher personnel and administrative cost have reduced and will likely continue to reduce operating profits for a protracted time in the future. Within this context, the management team at the company is now focused on new growth initiatives, namely greater integration with banking platforms, enabling online dating capabilities, and providing encrypted messaging services. The new growth initiatives are expected to "balance the wheel" as the company travels on more rocky terrains.

Walking a Tight Rope

As the company seeks to further diversity and grow its revenue stream, they face a catch-22 situation as the new growth initiatives require heavy private data usage at a time when the public has major concerns about privacy. Facebook recently approached financial firms such as PayPal, Citibank, and American Express, about allowing their customers to use facebook chat to communicate with customer service representatives. As part of the arrangement the banks would have to share data on card transactions and checking account balances. The company also announced the upcoming release of their online dating platform which will collect more sensitive data on people's relationships and dating history. Over the years, the company has not really placed a lot of focus on WhatsApp, perhaps choosing to pick the low hanging fruits, such as better integration of Instagram with the classic facebook platform, and improvements in the infrastructure that underlie video based sharing. In recent times, the company also announced sweeping changes to the WhatsApp platform in a bid to further monetize the chat technology, and provide more data encryption as a means to ease concerns about data privacy. Monetizing the chat technology will likely involve analyzing and storing more user text messages so that more customized advertisements can be sent to users.

At the same time, regulatory scrutiny continues to snowball. Recently, a New York senator - Luis Sepulveda - tabled to a bill to restrict data usage, on top those that have been introduced in the European Union. There are also plans to issue major fines to Facebook and the other big tech companies for improperly storing and sharing data amongst their partners. Going forward, it will be interesting to see how Facebook balances the demands of regulators with the responsibility to keep shareholders happy. Facebook currently trades with multiples well in excess of 25X, but has back that up so far with growth rates in the 30% +. If the company is not able sustain these rates or growth rates in double range, investor maybe disappointed in the quarters to come.

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