I once considered Facebook (META 3.04%) a solid long-term investment. More than 3.2 billion people use its family of apps -- including its core platform, Messenger, Instagram, and WhatsApp -- every month. It's a dominant digital advertising platform, and it's still generating double-digit revenue and earnings growth nearly 17 years after it was founded. Facebook's stock also still looks reasonably valued at 25 times forward earnings, especially in a market filled with frothy tech stocks.
But despite all those strengths, I recently sold my stake in Facebook. I did so for three reasons.
1. Its business model is unsustainable
Facebook generates nearly all its revenue from targeted ads. Through Facebook's platform, advertisers can target specific users based on their social media profiles, social interactions, and activities on third-party apps and websites.
Image source: Facebook.
This programmatic process is mostly automated and controlled by algorithms instead of humans. On paper, this seems like an efficient and self-sufficient business model. In reality, it creates echo chambers in which Facebook's users only see the ads they expect to see -- which can cause chaos when political ads are involved.
Unlike Twitter (TWTR), which banned all political ads in late 2019, Facebook continued to sell political ads, albeit with stricter guidelines. However, misleading ads have still slipped through, and it has struggled to moderate hate speech, threats of violence, and misinformation across its platform with its AI algorithms and outsourced moderators.
That toxicity culminated in the deadly Capitol riot in early January and Facebook's subsequent decision to ban President Donald Trump from its platform. But that move doesn't really solve anything -- Facebook's business is still built on an endless cycle of collecting data and building targeted ads, and any moves to limit engagement rates (such as preventing users from positing links to news stories and videos) would disrupt its growth.
2. Tighter regulations are inevitable
Since Facebook has repeatedly underestimated the ability of people to weaponize its platform -- as we've seen in Myanmar, Uganda, and now the U.S. -- a government intervention seems inevitable.
In December, the Federal Trade Commission sued Facebook for "illegally maintaining its personal social networking monopoly" with "anticompetitive conduct" and its acquisitions of Instagram and WhatsApp. If the FTC wins the case, Facebook could be forced to divest Instagram and WhatsApp, and seek out government approvals for future acquisitions.
Lawmakers, especially Republicans, are also attempting to reform Section 230 of the 1996 Communications Decency Act, which shields social networks from lawsuits over content posted by their users. The Capitol siege could revive those efforts, and hold Facebook fully accountable for the actions of its users.
Even Facebook CEO Mark Zuckerberg seems to favor tighter regulations. At the Munich Security Conference in Germany last February, he said he didn't "want private companies making so many decisions about how to balance social equities without any more democratic process." That uncertain tone indicates that even Facebook isn't sure how to properly manage its platforms.
3. Its revenue growth per user is stalling out
Facebook is still growing at an impressive rate. Daily users across its family of apps rose 15% year over year to 2.54 billion last quarter, as its monthly users grew 14% to 3.21 billion. Facebook's total revenue also rose by 22%. However, its family average revenue per person (ARPP) hasn't increased significantly since it started disclosing the metric at the end of 2018:
Image source: Facebook.
Facebook's family ARPP still grew 7% year over year during the third quarter, but that growth trails its total growth in users and revenue. Upcoming headwinds, including Apple's opt-in requirement for data tracking on iOS 14, could make it even tougher for Facebook to increase its average advertising revenue per user.
In other words, Facebook needs to continually gain more users to maintain its double-digit-percentage revenue growth -- but that could be challenging as it saturates its core market and faces competition from resilient rivals like ByteDance's TikTok, Snap's (SNAP 3.63%) Snapchat, and Pinterest (PINS 2.40%).
Facebook is also still struggling to lock in younger users. In Piper Sandler's latest "Taking Stock with Teens" survey, 54% of U.S. teens chose Snapchat as their top social networking platform, followed by TikTok and Instagram. That troubling trend could be rippling across other markets worldwide.
The bottom line
Facebook was once a great investment, but the tech giant seems to have lost control of its own platform. Zuckerberg famously told his employees to "move fast and break things," but clearly didn't realize it would break apart society with tribalism and misinformation. Until Facebook starts gluing those pieces back together into a sustainable business, I'd rather put my money in other tech companies instead.
