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How Facebook Inc (FB) Stock Turns Lemons Into Profits

Over the past few months, Facebook Inc (NASDAQ:FB) has had to revise its advertising metrics several times to account for errors. For the most part, the errors seem relatively minor and have had little impact on FB stock.

In September, management disclosed that the reported figure of average time spent viewing a video was inflated. A company post in November cited a summary figure of “reach” (the number of Facebook users who viewed an impression in their timeline) as being overstated.

In two more posts the following month, further problems were announced and more changes were made. The company changed its methodology for measuring reach (not just reporting the figure). “Reactions” to live video were mis-allocated, and counts for “likes” and “shares” had been miscalculated.

Again, Facebook stock investors seem relatively unconcerned. In fact, the FB stock price sits at an all-time high. But, combined with general concerns about “click fraud” and other problems in the online advertising space, the metric changes highlight a key issue for Facebook — and online advertising as a whole.

How Facebook responds as a company will be key for Facebook stock.

Click Fraud, Bots and Facebook’s Response

In a widely cited figure, the Association of National Advertisers estimated that online ad fraud would cost $7.2 billion in 2016. (Bear in mind that Facebook alone generated $27 billion in revenue last year.) Estimates of how many ads are fraudulent range from 30%-60%. Indeed, many analysts have forecast a collapse in the online advertising space as a whole.

Much of the questionable activity comes from bots, which mimic actual online users. There are also “click farms,” malware and display tactics such as “pop-under” ads, which are rarely, if ever, seen. Most of the complaints are directed at traffic generators and other middlemen. But, some argue that programmatic marketplace operators such as Rocket Fuel Inc (NASDAQ:FUEL) and Criteo SA (ADR) (NASDAQ:CRTO) are turning a blind eye to these issues.

Facebook is not implicated in these tactics. In fact, the company’s efforts outside the platform have shown a notable willingness to fight low-quality tactics. In 2016, Facebook shut down its Atlas ad-buying platform. Its head of ad tech wrote in a blog post, “We were amazed by the volume of valueless inventory” coming into that exchange. That poor traffic was a key reason for management’s decision to move on.

Another unit, LiveRail, was shut down last year as well. Facebook paid a reported $400 million-$500 million for that company, with the goal of building a video ad exchange. But, similar to Atlas, fraud and traffic concerns led FB to shut down the ad exchange. (In both cases, Facebook has salvaged measurement capabilities from the business.)

The irony of the questions surrounding Facebook’s metric changes is that, so far, when confronted with the worst of the worst in online advertising, the company has acted in a seemingly ethical manner.

But the question for FB stock is what the apparently worsening state of ad tech means going forward.

Are Growing Ad Tech Concerns a Plus or Minus for Facebook Stock?

The core concern regarding not just fraud, but poor measurement of online advertising impressions and click-throughs, is that advertisers can’t accurately gauge ROI. Facebook’s recent measurement errors — including inflated video duration figures for more than two years — seem of a piece with that concern.

There are other issues with the Facebook platform, too, including fake accounts, for instance. In the filings ahead of the Facebook IPO, the company estimated that 8.7% of accounts were fake. That figure was later updated to a range of 5%-11%. Click farms lead to paid promotions for users that aren’t real potential customers. The same issues that plague online advertising more generally seem to pop up for advertisers on Facebook as well.

But, there’s an argument that the problems in online advertising could represent another growth driver for Facebook stock. The company’s closed ecosystem eliminates many of the middlemen that are alleged to cause the disruption in programmatic marketplaces. While there are fraud problems, management continues to aggressively work to resolve those problems.

Facebook’s long-term growth potential — which, in the end, will drive FB stock — is based on happy customers. But keeping happy customers means Facebook must fix any potential fraud problems as quickly and aggressively as possible.

Facebook is doing just that. Management announced last week that it would submit to third-party auditing by the non-profit Media Rating Council. Twenty-four third-party companies now have access to the platform to improve measurement. FB is providing more data, and more options for buying as well.

If the concerns about online advertising are accurate — and there’s an awful lot of evidence at this point — Facebook seems better-positioned than its rivals, should advertisers pull back. Rather, Criteo, Rocket Fuel and even Alphabet Inc (NASDAQ:GOOGL) seem far more at risk.

In that scenario, actually, Facebook’s attractiveness to advertisers would only increase. A closed platform, improved measurement capabilities and third-party verification would offer confidence to those advertisers not available elsewhere on the Web.

And that would be a boon for FB stock.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2017/02/how-facebook-inc-fb-stock-turns-lemons-into-profits/.

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