Facebook Stock Is Still a Buy Despite China Risk

Despite China risk, Facebook should still spin off its other platforms

For investors wanting to focus on Facebook’s (NASDAQ:FB) fundamentals, it has been a year full of distractions. Just about every week, it seems, some new political headline or scandal comes out. FB stock has been a classic example of headline risk. You never know what you’re going to get in terms of the latest news from Facebook.

FB Stock: Facebook Stock Is Still a Buy Despite China Risk
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There has been no change on that front lately. The company has been hit with more privacy scandals, including a major failure to control user data. Political candidates continue to use big tech as a punching bag on the campaign trail. And foreign politicians are involved as well. For example, on Wednesday, Ireland — which leads data compliance oversight for the EU — announced a new investigation against Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL). The EU regulators have already levied large fines against Google, so this is another troubling development for big tech. Now there are concerns about the impact of the China tech battles on FB stock.

Add it all up, and it’s worth revisiting the question of whether Facebook is better off as one company or several. The political winds seem to be blowing increasingly in favor of smaller tech companies rather than a few giants. So what’s the right play for Facebook, and what does it mean for FB stock?

The Case For Facebook Splitting Up

Last November, here at InvestorPlace, I suggested that Facebook should spin off Whatsapp and Instagram. My argument was that “By spinning off WhatsApp and Instagram, FB could avoid taxes and attract new investors.” There are three good reasons to think about splitting Facebook into its component parts.

First, it should lower the overall tax burden. Countries, in particular European ones, are launching or considering taxes on large tech companies. Some Democratic presidential candidates seem to be considering such a policy as well. By making Facebook three smaller companies, it should lower their exposure to these taxes to some degree.

Second, a split-up Facebook gives investors new options. Some folks like the stable, giant cash flows that the Facebook legacy platform throws off. This company would presumably trade at a lower P/E ratio and offer a nice dividend. Instagram would be an attractive high-growth stock targeting wonderful advertising demographics. Meanwhile Whatsapp would be an interesting standalone play on a variety of things such as emerging markets, where the app is huge, and potential mobile banking and payments solutions. It’s not hard to see how these three companies could be worth a lot more than FB stock alone is today.

And finally, there is the regulatory matter. Some politicians from both sides of the aisle are talking about breaking up the tech giants. President Trump, for one, when asked about it last year said, “I am definitely in charge, and we are certainly looking at it […] That doesn’t mean we’re doing it, but we’re certainly looking at it.” Meanwhile, various Democratic candidates are taking tough stances on the tech companies. With another election coming up, tech companies will face heavy fire if anything manipulative happens on their platforms that disenfranchises voters.

Can Facebook Truly Break Up Given the Chinese Threat?

The case for splitting up Facebook makes a great deal of sense. Recently, however, the trade war has added a new angle to the discussion. Not surprisingly, Facebook’s executives have argued that the company doesn’t need to break up. Generally, management has incentives to maintain the status quo.

Now, however, Facebook is making a novel argument for why it should be allowed to maintain itself as a giant tech conglomerate. That reason, they say, is China. Sheryl Sandberg recently said, “While people are concerned with the size and power of tech companies, there’s also a concern in the United States with the size and power of Chinese companies, and the realization that those companies are not going to be broken up.”

For what it’s worth, Mr. Zuckerburg also commented last year, when testifying in Congress, that Facebook and other tech giants would risk falling behind Chinese technology if the government regulated too heavily. At the time, it seemed like an idle threat. Given the recent developments with Huawei  in particular, however, this is turning into a real issue. It’s almost certain that China will retaliate heavily against American tech companies if its major players are locked out of key international markets.

All that said, I’m not sure this works as a get-out-of-jail-free card for Facebook and other tech titans. They’ve taken advantage of their power. Companies like Google have run into numerous problems in Europe. And Facebook’s political scandals loom large, to say nothing of their repeated problems with handling data and upholding consumer privacy. I’m not sure politicians will turn a blind eye to these issues merely because China is a mounting concern.

FB Stock Verdict

Facebook management’s argument that they need to stay together for national security purposes is interesting, but I’m not sure I find it that compelling. There are still a lot of benefits that Facebook could achieve by splitting into three companies. It’d reduce regulatory risk while unlocking more upside in the company’s various assets.

That said, we’ll have to see how the Huawei scandal and the trade war in general play out. One thing is for sure, FB stock will remain a political football in coming quarters. With the company’s attractive sub-20x forward P/E ratio, wonderful balance sheet, and huge cash flows, however, FB stock remains a compelling holding despite the political headaches. Barring a wider market selloff, FB stock should reclaim the $200 level this summer.

At the time of this writing, Ian Bezek owned FB stock. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2019/05/facebook-stock-is-still-a-buy-despite-china-risk/.

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