FB: Systemic Mismanagement Introduces New Risks -- Pivotal Research

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Facebook is exhibiting signs of systemic mismanagement, which is a new concern we had not contemplated until recently. Recall that our negative view on Facebook's stock has been primarily due to concerns about limits to growth for digital advertising in general and for Facebook in particular, which means more rapid deceleration than consensus expectations in our model's latter years. Relatedly, we have been concerned about rising costs to support revenue growth as well as higher costs required to manage a variety of issues, such as with content moderation or higher costs to vet partners and advertisers.

However, what has come to light with the past week's revelations potentially represents a different class of problem when put in context with other issues that have arisen in recent months. To organize these concerns, in this note we have separated issues which are due to bad luck or bad choices vs. those which should have been prevented, cataloging groupings of some of the operational problems that have occurred since the end of 2015.

Facebook has addressed some of its problems, and presumably will address the remainder or eventually be compelled to do so. However, investors now have to consider whether or not the company will conclude that it has grown in a manner that has proven to be untenable or whether it needs to significantly improve how it is managed. The former scenario would depress the size of the company, but the latter scenario introduces the possibility (and related risks) of personnel changes at some point in the not-too-distant future. Both of these scenarios are incremental risks to those previously contemplated in our analyses. We continue to rate FB stock Sell with a $152 YE2018 price target.

Additional details and commentary follow in the remainder of this note.

VALUATION. We value FB on a DCF basis, with a 5.5% long-term growth rate, a 8.5% near-term discount rate and a 11.2% long-term discount rate.

RISKS. Risks for web publishers relate to: 1) high degree of rivalry given absence of barriers to deter new competition from emerging 2) high and increasing capital needs and 3) government regulations/consumer pushback related to data management.


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