UPDATED 16:40 EST / NOVEMBER 01 2017

APPS

Facebook smashes earnings forecasts, but site abuse crackdown will hit profits

On a day when Facebook Inc. and other tech executives were being grilled by Congress on how they may have helped Russia influence U.S. elections, the social network giant issued an earnings report that indicated its business continues to breeze ahead unaffected. But maybe not for long, as rising expenses on a number of fronts will hit profits.

The company said today that profits in its third quarter leaped 79 percent, to $1.59 per share, more than the $1.28 a share analysts had expected. Revenue rose 47 percent, to $10.3 billion, also higher than the $9.84 billion analysts had forecast.

As always, Facebook’s booming advertising business was the driver. Mobile ad revenue continued to grow, now at 88 percent of overall ad revenue, up from 84 percent a year ago. “Video is exploding, and mobile video is a big opportunity,” Chief Operating Officer Sheryl Sandberg said on the earnings conference call.

However, even in prepared remarks, founder and Chief Executive Mark Zuckerberg (pictured) felt compelled to nod to recent problems with exploitation of its platform, now a prime source of news, fake and real, for many people. Although Facebook continues to do well financially, he said, “none of that matters if our services are used in ways that don’t bring people closer together. We’re serious about preventing abuse on our platforms.”

On the earnings call, Zuckerberg went further, adding that he wants to make sure Facebook doesn’t “undermine” the “foundation of our society.” He said Facebook is working on providing more transparency on its ads and their buyers than television ads do. “We’re doing a lot here,” he said, including doubling engineering efforts focused on security in various areas. “I’m dead serious about this,” he added.

Perhaps recognizing that the gap between its booming profits and the problems on the site might garner notice in Washington D.C. and on Wall Street alike, he added: “We’re investing so much in security that it will impact our profitability. Protecting our community is more important than maximizing our profits.”

Shares have kept rising this year, by some 60 percent so far since January, despite ongoing controversy over Russia’s use of Facebook to run ads and other content during the political season and, even more relevant to its business, new concerns over the effectiveness of its mobile video ads. In regular trading today, they set a new record, rising 2.6 percent, to $182.66.

But shares soon were falling nearly 2 percent in after-hours trading as it became apparent that both the security and other spending will weigh heavily on future profits.

On Tuesday, in fact, Facebook General Counsel Colin Stretch said the company will double the number of staff working on safety and security, to 20,000, by the end of next year. And last month, the company said it would hire 1,000 new workers to review ads for adherence to its policies. That’s on top of 3,000 content reviewers Facebook said it would hire to police violent videos. “This increase in security spending is very unfortunate, but it’s highly appropriate,” RBC Capital Markets analyst Mark Mahaney said during the call.

But that’s not all. On the call, Chief Financial Officer David Wehner also detailed other looming issues that could hit profits. For one, Facebook expects its revenue growth rate, which declined for the fifth straight quarter, will see that trend continue for the foreseeable future. Also, he said, the growth will be driven not by a higher level of ads, as has been the case to date, but by higher ad prices.

What’s more, Wehner said, expense growth will accelerate next year not only from the security efforts but also video content for the new Watch tab and spending on augmented and virtual reality, artificial intelligence and internet connectivity efforts. All that will have a negative impact on operating margins, he said. Not least, he said, capital spending will double next year over 2017.

“Preliminary guidance calls for an increase of expenses of between 45-60 percent,” Pivotal Research Group analyst Brian Wieser wrote in a note to clients. “This is substantially above our prior expectations. However, we think the news is both unsurprising and in many ways positive, especially with respect to the company’s needed investments in safety and security.” Still, he said he’s reducing his valuation on the shares from $140 to $136 and has a “sell” recommendation on the stock.

Other analysts were less worried. Macquarie Securities (USA) Inc. analyst Ben Schachter said in a note that he’s raising his numbers for the company thanks to continuing growth of users and advertisers, as well as the potential of its video offerings.

“While the discussion around security and increased spend will generate a ton of media, the real issue for the model is if the video strategy will succeed,” he wrote. “If it does, and FB is able to build a legitimate YouTube challenger, the increased security spend will be a speed bump.”

Indeed, the Russia and other controversies hasn’t kept people away, as Facebook reported continuing gains in its already massive user base. The number of monthly active users hit 2.07 billion, up from 2.01 billion in the previous quarter, and daily active users reached 1.37 billion, up from 1.32 billion last quarter.

Facebook’s staff continues to grow as well, up 47 percent from a year ago, to 23,165 at the end of September.

Photo: Robert Hof

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