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Mar 11, 2021
We have received a number of questions recently about the battle between Apple and Facebook over targeted advertising. While we believe Apple’s new App Tracking Transparency Framework (ATT) will provide a major challenge for the digital advertising ecosystem, we do not foresee much impact on Facebook’s business over time.
What is Apple’s new App Tracking Transparency (ATT) framework?
Expected sometime in March, all iOS apps will be required to adopt Apple’s new App Tracking Transparency (ATT) framework. The framework requires that any app collecting user data to be shared with companies for tracking purposes must first obtain the user’s explicit permission. Since most users are unlikely to opt-in for tracking, it will become harder for advertisers to target specific user profiles, reducing the effectiveness of ads relied on by millions of businesses around the world.
Apple has highlighted this change as intended to strengthen protections around user privacy, while Facebook has painted a picture of Apple using its monopoly power over the App Store to cripple competition. As is usually the case, the reality is somewhere in the middle.
While Apple executives certainly believe in the importance of user privacy, these policy changes also look to be a boon for Apple’s services revenue. For example, if developers are unable to earn a living by offering free apps supported by targeted advertising, then they may be forced to choose a different business model like subscriptions, where Apple is happy to take a 30% cut of their revenue.
Whether Apple’s goal is to improve user privacy protections, or a cynical attempt to extract more revenue from app developers, is of little importance from an investor’s perspective. Apple has full control of the iOS app ecosystem and they set the rules, so we must accept them. Will these new rules cause major problems for companies like Facebook that rely on selling targeted advertising? Well, yes and no.
How digital ads work
To understand why these changes are likely to cause some short-term pain for Facebook, but limited long-term impact, it is important to understand the basics of digital advertising and what makes Facebook’s ad business particularly special.
There is a famous expression in the advertising business attributed to John Wanamaker: “Half the money I spend on advertising is wasted; the trouble is, I don’t know which half.” By tracking which users complete a purchase after clicking on an ad, Facebook has been able to solve this problem for many. Not only is Facebook able to understand which ads result in purchases, but they are also able to build profiles of users that made those purchases. Facebook can then show similar ads to similar profiles across billions of other users on their platform.
In the past, only large companies had the necessary resources to invest in building the data capture capabilities and attribution models needed to determine which ads were reaching the right audience and resulting in sales. Facebook was able to leverage their scale to make these same tools available to small businesses for the first time.
So, what is the likely impact of ATT on Facebook?
We expect Facebook will experience slower revenue growth this year once the ATT changes roll out, as some advertisers take a wait and see approach. However, there are several mitigating factors that position Facebook well for the future.
First and foremost, ATT impacts the entire industry, so Facebook’s strong position relative to other advertising options is unlikely to change much. Facebook also has many other signals they can rely on to improve the relevancy of ads shown to users. For now, Android users are not impacted by a restrictive framework like ATT, so those users continue to provide valuable information about which ads are effective. Additionally, many large advertisers already track which ads generate closed transactions, and they can continue to share this information with Facebook to improve ad targeting. Finally, Facebook has introduced a new feature called Shops, which enables businesses to “close the loop” without users ever leaving Facebook or Instagram. With Shops, users can click on an ad for a product they like and then purchase it directly within Facebook or Instagram, effectively replacing third-party transaction data that becomes much harder to obtain under ATT.
In addition, we are confident that Facebook can manage through these headwinds because management has a deep understanding of the impact from users opting out of third-party tracking based on their experience with European GDPR data privacy regulations. GDPR has had minimal impact on Facebook’s business so far, and management has guided for strong growth this year, despite ATT. However, the market is less certain and Facebook shares trade at a significant discount to the market multiple. We believe this near-term uncertainty creates an attractive opportunity for patient investors like Summitry willing to accept short-term pain in exchange for long-term gain.
If you would like to learn more about the mechanics of ATT and its impact on the digital advertising ecosystem, we have found the following resources very useful:
Interested in learning more about our views on the companies we invest in? Contact us today.
The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.
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Matthew Gordon, CFA®
Senior Equity Analyst & Portfolio Manager