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One way investors should value the Facebook scandal damage

  • As investors, we worry about the amount of revenue Facebook could lose and the increased money it must spend to police and monitor its site.
  • Facebook's stock is now down about 20 percent from its Feb. 1 peak, meaning that the company has lost over $120 billion of market value, three times its annual sales last year.
  • As the Economist points out, the median decline for a stock after a company crisis erupts is 30 percent, and we are 10 percentage points from that level.
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The sound of a televised golf tournament travels from another room. It's a late Sunday afternoon in spring, and habits in this house never change. I just heard fragments of a BMW ad, which is no surprise. Targeting is the essence and value of advertising, and golf tournaments deliver a well-defined audience of mostly upscale, male and middle-aged viewers.

Nielsen has been in the business of measuring and identifying TV and radio audiences for nearly 100 years. Beer ads during football games, Transformers ads across Nickelodeon, and Advil ads during 60 Minutes all result from advertisers digging through and analyzing audience data for those programs.

But this practice, also known as data mining, has taken on nefarious tones.

The current controversy about what Facebook does with its users' information has obviously rattled many people, including investors. On Wednesday, the social media giant raised the estimate for the number of users whose information was improperly shared with a consulting firm tied to the Trump presidential campaign, to 87 million from the previously estimated 50 million.

Shares of Facebook are up 2.6 percent on Thursday but have taken a beating from the latest news. They are now down about 17 percent from the Feb. 1 peak, meaning that the company has lost over $100 billion of market value, nearly three times its annual sales last year. If the stock decline reflects the number of people fleeing the platform, that would imply a loss of 340 million of its 2 billion users, which seems extreme.

The instant way advertisers can reach users seems to be one weak point. Consider how the pathway from ad to purchase varies across media.

In one scenario, Trip Advisor advertises during the TV broadcast of an NCAA basketball tournament game hoping at least some viewers will see the ad and decide to use the website to book travel, allowing the firm to collect a fee. There is a time lag and a few steps the consumer has to take between seeing the ad and using the website to complete the booking.

However, when I watch smart dog videos online (not at work!!) and click on the ad for the artisanal dog treat that has miraculously appeared in my Facebook feed, there is practically no lag time. It is an example of perfectly aimed and successful internet marketing.

In a recent interview, Barry Diller suggested that it is ironic that after reaching "the holy grail" of placing ads with "precise targeting," the internet is now being widely criticized for this "momentous" achievement.

Diller may have missed one critical point. When we watch a Rolex ad on the Tennis Channel, we have no doubt that Rolex bought that spot for several reasons, including cost and the lack of incentive for an imposter to advertise there.

On Facebook, however, a targeted fake Rolex ad, which would be relatively low cost, might lead browsers to click through and buy a watch immediately without verifying the authenticity of the messenger. The targeting can be precise, but the source of the ad might be opaque.

We are learning that one of the most intractable problems with the digital platform model is that advertisers pay to make impressions on viewers but impersonators abound. Awareness of counterfeit ads or "fake news" is likely to lower user confidence in the origination of Facebook ads, potentially reducing the click-through rate, and prompting advertisers to demand discounted rates.

Ad revenue accounts for virtually all of Facebook's $40.6 billion of sales in 2017. Media, entertainment, luxury goods and financial services are among the larger advertisers, and all of them could raise the issue of credibility erosion.

As investors, we worry about the amount of revenue Facebook could lose because of this spiral and the increased money it must spend to police and monitor its site. There is no question that the recent stock action in Facebook suggests tremendous fear about the scandal and its impact.

As The Economist points out, the median decline for a stock after a company crisis erupts is 30 percent, and we are 10 percentage points from that level.

But many pummeled stocks recover over the following six months after management moves to quickly address the cause. Equifax, another recent debacle, fell 35 percent in the week after the company announced a massive data breach last fall, but is up 26 percent since its nadir compared to 4 percent for the S&P.

At this point, we need to calmly analyze the information we have, the range of possible outcomes, the tax implications for selling Facebook shares now, and where we feel Facebook's users, advertisers and investors may go instead. Meanwhile, I'm buying a couple chew toys for the puppy.

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