Regulation Will Increase the Value of Facebook Shares
Time to Buy Facebook (NASDAQ: FB) @ $125/share (12/21/18)
Governments across the globe are attempting to regulate Facebook in an effort to limit the company’s ability to share their user’s data. The financial markets assume these regulations will negatively impact Facebook’s bottom line — they’re wrong. More than 4.5 million third-party websites and applications have access to their user’s Facebook accounts through a feature called Facebook Connect. Once regulators force Facebook to shut down or limit their Graph API, more advertisers will be forced to purchase more ads on Facebook resulting in higher revenues and greater profits for the social network.
It should be no surprise that the two charts detailing Facebook’s user growth and revenue growth are very similar but if you look closely they are not identical. The revenue chart hasn’t kept pace with the user growth for one very simple reason — to hasten Facebook’s growth the company has shared their user’s data with third-parties through a feature called Facebook Connect. This data sharing necessarily has resulted in lower revenues for the company as their partners are able to leverage Facebook’s data for their own bottom lines instead of buying access to the data through Facebook’s ad platforms. Once these partner programs are regulated out of existence I predict the revenue growth chart will take off like a rocket.
So what happened? Why did the world wake up twelve years after its launch and decide that Facebook shouldn’t be sharing their data? The Facebook partner that ultimately caught the attention of users and regulators was a small firm called Cambridge Analytica. In 2017 the firm generated a paltry $5.7M in revenue with a net operating loss of over $13M. The company was in the process of moving from away from their failed data-science business model to focus on commercially related work using off-the-shelf data-targeting products from Facebook.
Shortly after President Trump’s victory Jered Kushner was on the cover of Forbes explaining how the campaign’s use of data helped his father-in-law win the White House. Reporters began digging into public records from the FEC to determine which vendors may have been involved and eventually uncovered $5.9M in payments to Cambridge Analytica from the campaign. It was the beginning of the end for the failing company.
Executives from Cambridge Analytica bragged to these reporters about how they used their proprietary ability to leverage data from Facebook to swing the election for Trump. The irony is that they were lying — the company’s dataset was too small and disconnected to provide any real advantage. Instead, according to shareholder documents, the company actually used Facebook’s off-the-shelf tools to run 100,000 different ad campaigns — the same tools every other Facebook advertiser in the world uses.
Facebook offers advertisers like Proctor & Gamble, Donald Trump, and Cambridge Analytica VERY powerful targeting tools. For example, let’s say you want to raise money from Democratic voters and their friends. Facebook allows an advertiser to upload the email addresses of their existing donors to determine how many of them have Facebook accounts — generally a 74% match rate for most email lists. Then Facebook will allow the advertiser to send fund raising messages to the Facebook friends of their existing donors — but the company doesn’t stop there. In an effort to get more ad dollars Facebook will use their user’s demographic data (likes, dislikes, education, address, etc) to create an audience that looks just like the advertiser’s email list — turning a list of 1,000 donors into a facebook audience of over a 1,000,000 in just a few seconds.
Cambridge Analytica had barely 50,000 users and as a result had relatively limited data from Facebook Connect. To meet the needs of the campaign the company basically shelved their data-science project in favor of Facebook’s publicly available off-the-shelf advertising tools for the campaign. Facebook user and revenue growth has been a direct result of the company’s ability to sell their user’s data. Don’t get me wrong, Facebook Connect’s data is very powerful, but it is completely dependent on the partner’s user reach — the more users they have the more valuable the data is. Cambridge Analytica’s reach was simply too small to be of any value to the campaign — Facebook’s standard tools were 1000x more powerful and effective.
Since 2008, billions of Facebook users have used Facebook Connect to login to another company’s service. More than 4.5 million websites allow their users to login with their Facebook account and almost every Facebook user logs into one or more third-party websites using Facebook Connect each day. How did Facebook manage to get millions of companies to use their login system? Simple. They share a LOT of data about their users with their Facebook Connect partners.
For example, here is the data a Facebook Connect partner can ask for from Facebook when you use your Facebook account to login to their website or application. The revelation that Cambridge Analytica had the [user_friends] data for 50,000 Facebook users rocked the internet — but anyone who understands how Facebook makes money realizes that their access was a drop in the ocean. Most of the largest websites and applications use Facebook Connect and they have hundreds of millions of users and they can ALL access the [user_friends] field. Both the Republican Party and Democratic Party have MILLIONS of users on Facebook Connect — neither had any use for the data Cambridge Analytica had.
Facebook Connect has been a huge growth driver for Facebook, but it isn’t terribly important today. Facebook already won. They’ve got ALL of the users. They don’t need help from third-parties anymore. Governments are going to start regulating Facebook’s ability to share the data they collect on their users and it will likely help Facebook generate even more revenue. Third-parties who leverage data from Facebook Connect on their own platforms will now need to buy targeted ad products from Facebook once their access to raw data is limited by U.S. and E.U. regulators.
The world is upset at Facebook for sharing their data and as a result Facebook is going to stop sharing their data. The irony is when Facebook stops sharing their data the company will become even more dominant and more profitable. Facebook’s users ARE the product they’re selling and thanks to government regulators there will be only one place to buy them — on Facebook.
When I wrote this story Facebook stock was at $125/share (12/21/18). While this might have been the bottom, the data I’m looking at shows FB could go to $99/share — don’t worry…