July 26, 2018 / 5:47 PM / 5 months ago

Breakingviews - New Facebook pessimism overshoots reality

3D-printed models of people are seen in front of a Facebook logo in this photo illustration taken June 9, 2016. REUTERS/Dado Ruvic/Illustration

NEW YORK (Reuters Breakingviews) - The sudden new pessimism surrounding Facebook has overshot reality. Forecasts of reduced growth and margins wiped nearly 20 percent, or about $120 billion, off the social network’s valuation overnight after it reported second-quarter earnings on Wednesday. That’s an astonishing hit, and one of the largest dollar falls in a company’s market capitalization ever. It’s replacing excessive optimism with undue glumness.

Mark Zuckerberg’s creation, now worth a bit over $500 billion, has a slew of problems. The number of users on its main site has plateaued in the United States and Europe. Constant stories about the mishandling of data, toxic content and state-sponsored misinformation also raise questions about the attractiveness of the platform for advertisers and users alike in the future.

Step back, however, and Facebook’s new guidance isn’t that bad. Revenue grew 42 percent in the last quarter from a year earlier, compared to a 49 percent pace of expansion in the first quarter. Interpreting the company’s remarks, the growth rate could slow to below 30 percent by next year. That’s about the same as Google parent Alphabet. Moreover, Facebook thinks operating margins will fall to around 35 percent within the next several years – still about 10 percentage points higher than its big internet rival.

After the plunge in its market capitalization, Facebook is now valued at about 27 times estimated earnings over the next 12 months, according to Thomson Reuters figures. The S&P 500 Index trades at nearer 17 times forecast earnings. Assume constant margins, and that implies Facebook will increase earnings a bit over 10 percentage points faster than the index for four years and subsequently at the same pace, by Breakingviews calculations.

Consider that a reasonable long-term guesstimate of S&P 500 earnings growth is under 10 percent a year – probably nearer 5 percent – and even factoring in a margin squeeze, Thursday’s valuation for Facebook seems too conservative. Its main, eponymous platform may be maturing, but it also owns fast-growing Instagram, which has over 1 billion users, and WhatsApp, which has even more users as yet largely untapped for revenue.

The $870 billion Alphabet could be a still better bet. Its valuation multiple is just a smidge higher, yet earnings growth and margins remain buoyant. While Facebook is sorting itself out, Google might land more advertising business, too.

Breakingviews

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