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EU Heightens Scrutiny of Facebook

In light of increasing and intrusive oversight, regulatory risk not adequately priced in the stock

European regulators continue to spar with Facebook Inc. (NASDAQ:FB) in a process of oversight that seeks to reign in one of the largest tech companies in the world. The first shot across the company’s bow occurred last June, when the European Commission implemented the provisions of the General Data Protection Regulation, aimed at protecting users’ privacy rights. At the time, Facebook and other social media companies faced the specter of potentially large fines for noncompliance.

The latest EU provision will force Facebook to more fully, clearly and adequately disclose and in terms its users can understand, exactly how the company profits from the use of its customers’ private data.

“Today Facebook finally shows commitment to more transparency and straightforward language in its terms of use,” Vera Jourová, EU’s commissioner for justice, consumers and gender equality, said.

Far too many research analysts focus on Facebook’s latest earnings announcements and conclude the GDPR or other comparable regulations have had no impact on its bottom line. It is quite alluring to believe that all is well: the company’s net digital advertising revenue in the U.S. increased dramatically from $17.42 billion in 2017 to $23.66 billion through 2018. It is quite easy to be seduced by such reassuring numbers.

Such reasoning is short-sighted, specious and ignores that the real risk to the company is not necessarily existing regulations, or those initially enacted last June, but rather the evolution or revision of existing regulation as well as new proposed initiatives. There is a natural lag between enactment of the regulations and the impact felt by the company being regulated. As the chart below indicates,

Facebook’s operating margins, long untouched in the 40% range,

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