“ Users are fickle, Friendster has proved that. Even a few people leaving would reverberate through the entire userbase. The users are interconnected, that is the whole point. College kids are online because their friends are online, and if one domino goes, the other dominoes go, don’t you get that?”
–“The Social Network (2010)”: Mark Zuckerberg’s character to Eduardo Severin on the importance of the network staying up.

Facebook has become the largest social network over the past decade as it now reaches 2.2 billion users or over one-quarter of the world’s population. The business is incredibly scalable as its software engineers have created a platform that is able to add millions of users each month without issues. The company is also improving functionality to users and advertisers as its cash flows grow. Facebook continually reinvests in its platform so that its ability to target its user base with relevant ads grows and the company expands its lead in the digital advertising arena.  Facebook and Google generate more than 60% of all digital ad revenue throughout the world. Finally, Facebook grew its revenues by 47% during 2017, which is staggering for a company of its size.

These characteristics make the company very attractive to investors. At its peak, Facebook sold for $195 per share with a market capitalization of over $560 billion. As of this writing, the stock is down to $155 per share having lost $100 billion in value. Current events are testing whether or not the destruction of the brand’s value can occur as rapidly (or even faster) than Facebook’s incredible rise.

The furor over Facebook’s privacy practices accelerated as it became known that personal data on 87 million users was shared with Cambridge Analytica, a political advocacy firm. In 2014, Facebook allowed Aleksandr Kogan, a professor at Cambridge University, to collect information from users that downloaded his app. Kogan’s app also targeted data from those connected “friends” of the ones who downloaded the application.

Cambridge Analytica gained notoriety for politically targeted advocacy on behalf of the Trump campaign in 2016 through its connection to Steve Bannon. It is difficult to imagine that many of the 87 million exposed Facebook users actively consented to their personal data being transferred to such a politically polarizing group as Cambridge Analytica.

Facebook’s business model rests on a Faustian bargain made by its users and licensees. Users agree to allow Facebook to collect information on everything they do through Facebook’s myriad products including Facebook, Instagram, WhatsApp and Messenger in return to use its products for “free.” Facebook then sells this data to advertisers and anyone else who pays Facebook for the privilege of targeting segments of Facebook’s userbase.

Facebook lists the data that it collects explicitly in its Privacy Policy. This policy states that Facebook will collect information on:

  • Things you do and information you provide
  • Things others do and information they provide
  • Your Network and communications
  • Information about payments
  • Device Information
  • Information from websites and apps that use Facebook’s services
  • Information from third parties
  • Information from other Facebook companies

The degree to which the software company can profile its user base is unprecedented. Contrast this level of privacy intrusion with the degree of privacy that the average Nielsen Family gave up and the comparison is astounding.

There has been a marked shift in the public’s perception of technology companies and their founders over the past few months. Technology companies rebounded after the NASDAQ bubble popped in 2000 and have been held in high esteem as their products have revolutionized computing and mobile interconnectivity. The founders of these ascendant companies such as Jeff Bezos, Larry Page, Mark Zuckerberg and Elon Musk have been viewed as enlightened philosopher kings whose benevolent work makes all of our lives easier and more rewarding. Shareholders have also experienced surging wealth as these stocks have appreciated greatly.

Facebook’s problems reflect how this perception has changed. Facebook is no longer a cool site to share photos and videos, but is now viewed as a privacy sieve that sells its data to the most Machiavellian elements in commercial and political arenas. Mark Zuckerberg is not solely a genius programmer who thumbs his nose at the establishment by wearing a hoodie, but a hypocrite afraid to address systemic issues with his business and defend forthrightly Facebook’s practices.

Public perceptions are important for two reasons. The first is that these perceptions drive demand, which in Facebook’s case is user engagement. Lower user engagement means that ads sold to those users are necessarily less valuable. The second impact of this change in perception involves regulation. A public that is upset by lack of privacy or other invasive business practices is more willing to support regulatory efforts to change the offensive conduct. Regulatory attention often takes years, but the effects are far reaching (see Standard Oil, IBM, AT&T, Microsoft etc.). All of these businesses lost incredible value as their managements were tied up defending past behavior while their competitors took market share in newer growing segments.

As Facebook’s valuation becomes cheaper, and it begins to look more attractive as an investment candidate in our work, the question we are examining is whether the Cambridge Analytica scandal is the first domino to fall in a series that could negatively impact the whole business model. Few of the most valuable 21st century businesses are built on vast amounts of capital and physical infrastructure as in the past. Instead, the foundations of these businesses rest on public opinion which is much more fickle and requires constant vigilance on the part of investment professionals.