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Abu Dhabi, UAEFriday 14 December 2018

Facebook alarm finally being heard

fourth-quarter revenue deceleration came despite firm's repeated warnings that its advertising sales growth would slow noticeably

A 3D-printed Facebook logo. Dado Ruvic/Reuters
A 3D-printed Facebook logo. Dado Ruvic/Reuters

Facebook has become the technology industry's boy who cried wolf.

The company kept warning that its rate of revenue growth would slow and that its plans to spend more money and remodel Facebook into less of a cesspool would drag down profit margins and perhaps result in people using Facebook less.

Investors learned not to be so concerned about Facebook's predictions of impending doom, although now it looks as if some of those cautions are coming true and outsiders weren't sufficiently braced for it.

Facebook said on Wednesday that its revenue in the fourth quarter of 2017 rose 47 per cent from a year earlier. Yes, that was (barely) the sixth consecutive quarter of slowing growth for Facebook; but come on, it's impressive for a company of Facebook's size to regularly boost sales at this pace. Out of 300 global companies of Facebook's size, only a few are growing more quickly, Bloomberg data show.

The fourth-quarter revenue performance came despite Facebook's repeated warnings that its advertising sales growth would slow noticeably at this point because of its decision to stop shoving more ads into the Facebook news feed. It's clear that Facebook more than made up the difference thanks to higher ad prices and new types of advertisements that appeal to companies eager to pitch to Facebook's giant audience.

Wall Street does expect Facebook's sales to slow meaningfully soon. Analysts think Facebook's revenue will increase about 33 per cent in 2018, according to the average of estimates compiled by Bloomberg. That's slow for Facebook but impressive in any rational world. It makes sense for any company to underpromise and over-deliver. But given how often Facebook has warned investors that its financials will start to look a little less handsome, they may not believe the company if the ugliness really comes this time.

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That's more of a worry now because Facebook has started to fire up the alarms about other elements of its business, and those appear to be coming true. CEO Mark Zuckerberg recently said his decision to change the formula to prioritise "meaningful social interaction" on Facebook might cause people to spend less time hanging out on the social network.

The company disclosed on Wednesday the slowest rate of growth in its history in the number of daily users. The number of users in North America fell for the first time in the fourth quarter. And Facebook said that the changes it made to play down viral videos and other less-than-optimal programming reduced the time spent on Facebook by roughly 50 million hours each day. That works out to roughly 2 minutes for each of Facebook's 1.4 billion daily users.

In principle, though, even a small reduction isn't good for Facebook's future advertising revenue because the more time people spend on Facebook, the more chances Facebook has to sell paid commercials. Facebook shares dipped about 4 per cent in trading after the regular market close before rebounding.

The worry, of course, is that Facebook's second quarter of relatively meek daily user growth may be the result of people's dislike of hanging out on Facebook. And that's an existential threat to Facebook's popularity and its business. That's worthy of five ringing alarms of caution. The changes Facebook made to its news feed were announced after the end of 2017. It seems likely, then, that slowing daily user growth in the fourth quarter wasn't caused by the news feed changes, and that more declines in time spent may be coming.

Other fears have yet to come to pass. Facebook has also said it will spend much more this year on people and technology to oversee posts and advertising, to avoid a repeat of the 2016 Russian-backed misinformation campaigns that remain the subject of congressional inquiry. It also plans to spend more on video programming for its TV-like digital hangout and to build up relatively young businesses including virtual reality and artificial intelligence.

Facebook has warned that this increased spending will hurt its profit margins in 2018, but investors don't seem to believe it. Wall Street's expectations work out to an expected 2018 operating income margin of 43 percent, Bloomberg data show. Facebook ended 2017 by posting a record 57 per cent quarterly operating margin. That gives the company room to spend more without dragging its margins to worrisome levels.

Facebook has been tamping down expectations for so long, investors didn't take seriously enough the company's cries of distress. And as the stock reaction from Facebook's user growth and engagement numbers show, investors weren't prepared for Facebook's warnings to come to fruition.