This was published 2 years ago
Opinion
Facebook’s implosion a wake-up call for investors
Stephen Bartholomeusz
Senior business columnistThose wild gyrations in markets late last week have enlarged the question marks over some long-standing convictions investors have had about the dominant technology giants.
The first was a view that all the big tech companies have similar attributes. Throughout the pandemic the share prices of the big tech companies – Facebook (now Meta Platforms), Apple, Amazon, Netflix, Google et al – have broadly moved in unison, or at least in the same direction.
Investors are finding out that tech giants are more vulnerable than they thought. Credit: AP
From the onset of the pandemic in 2020 until their share prices peaked last November the share prices of the “FAANG” companies, as that group is known, were up about 200 per cent as the lockdowns and incentives to stay at home saw a massive growth in online activity.
The second was a belief that network effects and scale made the tech giants almost invulnerable and guaranteed growth -- the more people who used them the more others were inclined to join the platforms, generating ever-increasing scale and revenues. To use Warren Buffett’s lexicon, companies such as Facebook, Apple, Google and Amazon were seen to have deep “moats”.
That led to growth, almost in perpetuity, being factored into the companies’ share prices.
Late last year the FAANG stocks were trading on an average price-earnings multiple of about 42 times. Without any earnings growth it would take 42 years for investors to get their money back, so investors were capitalising many, many years of very strong and unbroken earnings growth into those share prices.
When Facebook’s share price imploded last Thursday in New York, shedding more than $US230 billion ($325 billion) of market capitalisation, it shattered a number of those myths.
The fact that Amazon’s market value rose on Friday by almost as much as Facebook’s had fallen on Thursday after it posted a very strong financial result highlighted that not all big tech companies are the same. The increase in Amazon’s value was the biggest single-day gain in history; Facebook’s loss the largest once-day loss in history.
Facebook’s share price plunge was due to not just a poor financial result but its first fall in active user numbers its near 20 years of existence.
By itself that would have raised a major query over Facebook’s ability to maintain its dominance of social media – it cited competition from TikTok and others for the fall – but it was worsened by its disclosure that Apple’s new privacy rules, which allow its users to opt out of ad-tracking, would cost it $US10 billion.
The network effects of Facebook’s ever-growing (until now) user base had compounded into its revenue base as its users traded, willingly and knowingly -- or otherwise -- their privacy for access to the platform. Now both the user and revenue base have shrunk, raising the prospect that the network effects could work in reverse.
Facebook’s experience certainly undermines the notion that the network effects that had powered its growth would ensure continuing and unchallengeable dominance and self-fuelling growth.
It also underscores a market truism that when a high-multiple company falters the simple arithmetic of a shift to a lower multiple means it gets smashed.
Facebook isn’t unique. The first-mover advantages that powered Netflix’s rise and enabled it to invest in content at a rate far beyond its initial competitors has been undermined by the number and nature of competitors (including the big Hollywood studios) who have now crowded the streaming market.
Thus the Facebook experience says that the moats around big tech aren’t as deep or as protective as investors – and regulators – had thought.
The end of the pandemic surge in consumption of streaming services has added to Netflix’s challenge of continuing to grow its subscriber base at the rates at which it had grown in the past.
Even Amazon, with a more diverse portfolio of businesses than Facebook, is facing competition from retailers, big and small, who are responding to the change in consumers’ buying habits and the threat that Amazon poses to their business models and, indeed, their existence. Other big tech companies are targeting its lucrative cloud services.
Thus the Facebook experience says that the moats around big tech aren’t as deep or as protective as investors – and regulators – had thought and that their indefinite growth can’t be taken for granted, or priced into their shares.
That’s particularly the case when, unlike the past two years – indeed for more than a decade -- interest rates are rising and financial system liquidity is likely to shrink.
Facebook’s share price plunge was due to, not just a poor financial result, but its first fall in active user numbers its near 20 years of existence.Credit: AP
When interest rates rise, so does the discount rate used to calculate the present value of companies’ expected future cashflows. If rates are rising and those expectations are being downgraded implosions in companies’ share prices like the one that overwhelmed Facebook shares last Thursday are inevitable.
Higher rates and the start of a shrinking of the vast pools of liquidity that have been sloshing around the global financial system since the global financial crisis should also mean that the historically dizzy multiples on which shares have traded since 2008 should revert to something closer to historical norms.
At about 24 times earnings the US may be below the 30-plus multiple a year ago but, while rates are likely to remain relatively low even if there are four or five rate rises in the US this year and liquidity is likely to remain relatively plentiful by past standards for some years to come, that price-earnings ratio is still well above its mid-teens historical average.
The big techs have provided an elevated floor under markets throughout the pandemic but the experiences of Facebook, Netflix, PayPal and others is underscoring the differences between them and the acute vulnerability of their share prices to any development, internally or externally, that might threaten the investment thesis of consistent, superior and unchallengeable growth out into the distant future.
That makes the market potentially more volatile and riskier and ought to force investors to be more discriminating. That’s not necessarily a bad development.
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