Deflate the valuations

John Naughton, professor of the public understanding of technology at the Open University in London, writes in The Guardian:

…as it has become clear that the US Federal Trade Commission is about to impose a fine of $5bn (£4bn) on Facebook for violating a decree governing privacy breaches, the company’s share price went up!

This is neither extraordinary, nor extremely rare, nor unique to Facebook. If the market expects a company to lose $10bn, and the news comes out that it’s only going to lose $5bn, the stock will likely rally to the tune of $5bn in terms of the market cap. Even if the fine wasn’t expected, the stock price could still rise if the market grows that day. In this particular case, the $5bn fine plus the $6bn market cap increase only equaled 2% of the market cap at the previous day’s close. Supposing the market grew 2% on that day, it wouldn’t be surprising to see the stock also grow, albeit by less.

…It’s the biggest ever fine imposed by the FTC, the body set up to police American capitalism. And $5bn is a lot of money in anybody’s language. Anybody’s but Facebook’s. It represents just a month of revenues and the stock market knew it. Facebook’s capitalisation went up $6bn with the news. This was a fine that actually increased Mark Zuckerberg’s personal wealth.

This logic only works for the ephemera. The stock price had probably adjusted to the impending fine long before the FTC’s decision was announced, so Zuckerberg merely recouped some of that loss on Friday. More interesting is the fact that $5bn is close to Facebook’s monthly revenue and, according to MarketWatch, to its average quarterly net income for the last four quarters. Assuming these numbers hold throughout 2019, Facebook’s 2019 price to sales ratio is close to ten and price to earnings is close to 30.

These are pretty high, although not insanely high as in the recent past. If the regulator were seeking to “hit it where it hurts,” it would attempt to deflate these valuations. Some of the measures John Naughton proposes could probably achieve that. However, the title of his opinion piece, “Money’s no object for Facebook” is puzzling. Of course it is – what would happen to its shareholders’ net worth if its share price collapsed? For that to happen, the outlook for revenues and/or margins and/or free cash flow would have to sour, and a regulator could play a major part in this, although the FTC probably won’t.

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