Facebook Will Pay A Heavy Price In The Apple-FB Cold War (NASDAQ:FB)


In my previous look at tech, I discussed how Apple’s (AAPL) movement to the ARM paradigm is squeezing out Intel (INTC). This is likely to have a side-effect of benefitting Advanced Micro Devices (AMD). Today, I want to discuss Facebook (FB), specifically in light of how Apple’s iOS 14 will reduce targeted advertising, which Facebook relies on, to a large group of wealthy consumers (iOS users).

Apple Is Targeting Targeted Advertising

The change in question is iOS 14 – to be released sometime in 2020 – forcing its users to opt-in to targeted advertising. If you don’t know, targeted advertising is what allows advertisers to set parameters so as to place their ads in front of the audiences most likely to act on those ads. Targeted advertising has been the catalyst for digital advertising outpacing traditional forms of advertising in terms of spend allocation, due to the fact that advertising budgets generate higher ROI when companies can cater ads to specific audiences.

When iOS 14 forces users to opt-in (instead of opt-out, which would be a much more manageable reduction in the targetable user base for companies such as Facebook), we are likely to see Facebook lose a significant portion of incoming advertising spend. As an ex-marketer myself, I’ve experienced situations in which my targetable audience cannot exhaust my advertising budget. For example, a budget of $10k might be set per month for targeted ads but the available audience might have shrunk to where I only have $5k of my advertising budget withdrawn via Facebook’s display system.

With an increase in the number of advertisers turning to digital, this presents an even larger problem. Should the number of targetable users shrink, advertising costs will necessarily rise, as advertisers are now competing for a smaller audience. The damage will be two-sided: Facebook not maximizing its revenue via targeted advertising and advertising not maximizing their ROI via higher costs.

Not Good for the End User; Not Good for Facebook

Apple bulls might see this as a positive: Users will no longer be manipulated by advertisers who are specifically targeting them, perhaps resulting in Apple being seen as a more ethical device provider. But ethical questions aside, the user actually sees detriment from the reduction of targeted advertisements. Objectively, users can skip or ignore any ads they want, and the removal of targeted ads simply puts more irrelevant, annoying ads in front of them, creating a pre-web 2.0 environment in which advertisements were almost always a nuisance, partly because marketers with the most dollars could run the same ads continually.

Without targeting advertising, wrestling aficionados will be shown women’s fashion advertisements, missing out on advertisements for – say – local wrestling events. No one really benefits here. But users are highly likely to not opt in to targeted advertising, as the connotation of targeted ads is a negative one.

This is why companies that control their own advertising platforms use opt-out instead of opt-in. But the fact that non-targeted advertising is so much more annoying than its counterpart is also the reason for so few people opting out. Alphabet (GOOGL) is a good example here, with its YouTube platform. Installing adblock software to outright block YouTube advertisements is quite common these days. However, few take the steps (or even know the steps) to opt out of targeted YouTube advertisements, despite said steps being just a few clicks while logged into YouTube. Installing an adblocker, in contrast, takes more effort. It is advertisements as a whole that annoys users, not the fact that the advertisements are crafted specifically for them; indeed, that catering to the user is more beneficial than harmful. (As an experiment, try turning off personal advertising in YouTube and see whether you prefer those ads.)

An AAPL-FB Cold War?

And with the above thesis, I must question Apple’s intentions. I doubt this move is an altruistic one. Apple is possibly again attempting to squeeze out a tech rival. Facebook will thus be fighting a choice of uphill battles: Either convince users to opt-in to targeted advertising within iOS 14 or convince Apple to change its opt-in policy in the new OS.

Another possibility is Facebook going cold war with Apple and simply removing its apps from the App Store. Facebook and Instagram users would be forced to switch to non-iOS phones to use these apps. This move would be damaging to Facebook but also extremely damaging to Apple, given the popularity (and addictiveness) of social media apps. However, it could force Apple to reverse course.

In either case, Facebook will most likely see its digital advertising revenue below expectations for 2020. I have not yet seen this reflected in analysts estimates. The potential harm from iOS 14 on Facebook’s bottom line has mostly been buried amongst the euphoria from Facebook’s glowing earnings report.

Bearish on FB

The earnings bump should be viewed from short-term lenses. The iOS 14 problem is one of a longer time horizon. It is also quite a severe problem for Facebook if not solved once the iOS user base migrates to iOS 14.

Currently (as of July 31), FB is gapping up from its earnings report. However, price action over the last 30 days is showing a large divide between the smart money and dumb money. Specifically, the dumb money are buying dips, while the smart money is buying on momentum. Similarly, the dumb money is selling spikes, while the smart money is selling dips. Today’s earnings movement makes sense in this context, with the dumb money taking profits. We will likely see the smart money pushing FB’s price upward before the end of the day, but we have to watch the gap created today – it could be an area gap, especially in light of the iOS 14 news. I believe FB will fall into the gap before reversing course (indeed, my gap algorithm agrees and in fact shows this to be a profitable area gap).

My pattern recognition analysis shows FB is nearing is pullback/consolidation leg of its growth cycle. Statistically, FB should pull back 25%, but this seems quite large given the current market environment (e.g., optimism, Federal aid, etc.). Still, I tend to trust the data. See if you can spot the pattern, by the way:

(Source: Damon Verial; data from Tiingo)

How to Trade It

I believe a short position of FB is justified at this point. This is especially true if you are already long tech. You could run a pair trade, being long tech but short FB to hedge risk.

Here are my two suggested strategies:

Complex:

  1. Sell Aug14 $275 call
  2. Sell Sep4 $240 put
  3. Buy Sep11 $255 put

This play requires margin due to the short OTM call, but you can skip that leg if you want. Otherwise, sell another two-week out OTM call once the Aug14 call expires. We want FB to move down to $240 before September 4, at which time we close the entire position; close on September 4 if we don’t hit our goal before then.

This strategy gains in value with time due to the short options having larger theta decay than the long put. Because FB just reported earnings, we can expect volatility to fall or remain low, which is good as this strategy is short vega (it gains value as implied volatility falls). If you want to continue holding this play after FB hits $240, simply close the short put.

Simple:

Buy Aug28 $255 put

Happy trading!

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in FB over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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