The recent controversy over social media and the use of its user data is likely to persist. Many users may not understand that researchers can accurately profile individuals on something as simple as their Facebook “likes”. The potential for influencing in subtle ways both consumption and more controversially political behaviours through targeted advertising should be clear. Multiple investigations across jurisdictions may now cast a harsh light on business practices which may otherwise have continued under the radar. Global digital titans which have become in effect brokers of user data are therefore under threat on another front, in addition to a recently proposed digital revenue tax.
VW’s “Dieselgate” was also in part about giving customers something they wanted without paying for it, namely fuel economy and performance. The externality of lower air quality took years to surface and many individual consumers may not even have cared. It was however a breach of regulations and perhaps more importantly consumer trust which ultimately proved very costly.
“Free” social media platforms in some respects have taken the hidden cost model into the digital dimension. While Facebook may be centre-stage today, all free to use/use my data social media businesses are at risk of increased regulation or a change in consumer preferences. After Dieselgate, VW pivoted towards electric cars, not because diesel was banned, but because that is what customers demanded. The combination of a loss of brand credibility, significant fines and increased investment in the company’s new direction contributed to a two year period of share price underperformance.
In situations such as BP’s Deepwater Horizon catastrophe, the initial corporate response is often to downplay or deny the magnitude of the situation. This strategy is high risk as if it does not succeed, there is every incentive for regulators, lobby groups and politicians to amplify their complaints in respect of a firm’s failure to acknowledge wrong-doing. The turn in investor sentiment is more likely to come when management accepts that business practices will have to change, enabling them to start to influence the process and create a strategic plan to exit the penalty zone.
We have had reservations in terms of taxation and data usage or privacy risks in respect of the larger digital companies for some time, as this was not being widely discussed or priced into valuations. Notably excluding highly-valued Netflix, the average forward EV/EBITDA for a number of the best known US technology stocks has risen by 25% over the last 3 years to peak at over 17x in early 2018, a valuation level which offers limited scope for disappointment.
The concerns over the use of user data stem in a large part to just how valuable it is to marketers and the political process, particularly if voters are micro-targeted with advertising or selected news feeds. For consumers, the wake-up call is that this data can influence their behaviour in very subtle ways which they may not be aware of, and is not necessarily in their best interest as they are users, rather than customers or clients.
However, this crisis need not be existential for the industry if skillfully handled and with recognition of the duty of care owed to societies which have generated these vast digital databases. Nevertheless, the permissive era when large-scale but still ‘cool’ digital companies could get a free pass from the rules set for older industries, whether in terms of business practices or taxation, appears to have passed and we believe valuation norms also still apply.