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Coronavirus Hurts Digital Ads Less Than Expected

The pandemic has pushed businesses to more rapidly start and complete their digital transformation.

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We have increased our estimates for Alphabet (GOOG)/(GOOGL), Facebook (FB), Pinterest (PINS), Snap (SNAP), and Twitter (TWTR) as the coronavirus-related hit to digital advertising looks softer than we initially anticipated. We think advertisers will continue to allocate more of their ad dollars toward direct-response campaigns after the pandemic. The main beneficiary of what may become a lasting change is likely to be Facebook. Investments by Pinterest and Snap to enhance their direct-response offerings will probably partially offset the impact of lower spending on broad-based campaigns. The same could be true of Twitter, but to a lesser extent. At Google, we expect search to attract more advertisers, given the overall decline in ad prices. Plus, assuming no significant lockdowns by the second half of 2021, we expect Google and Snap to more effectively monetize their map apps. The adjustments to our projections lift our fair value estimates for Alphabet 9% to $1,520, Facebook 14% to $245, Pinterest 4% to $27, Snap 6% to $18, and Twitter 7% to $32.

Digital ad spending in the second half of this year is likely to be higher than in the same period of 2019. According to a survey of advertisers conducted by the Interactive Advertising Bureau in mid-June, more ad buyers said they plan to increase ad spending on social media and paid search than to not change or decrease their spending during the next six months compared with last year. The survey also showed that the increase will probably come at the expense of traditional advertising spending. The survey indicates that advertisers may increase their social media and paid search spending by at least 25% and 20%, respectively, from the second half of 2019. Earlier this month, eMarketer published its latest estimates for 2020 digital ad spending, which it now believes will increase 2% year over year, well above our initial projection in March of a 5%-10% decline.

In our view, most of the higher spending over the next six months will be on direct-response ads, which make campaign results more measurable in real time and have historically generated higher returns on investment. The continuing shift toward e-commerce, which the pandemic has accelerated, has also pushed advertisers to spend more on these bottom-of-the-funnel campaigns. EMarketer estimates that retail e-commerce will grow 18% in 2020, while overall retail sales will decline 10.5% from last year. Increased adoption of e-commerce should further increase direct-response ROIs.

We think the coronavirus has pushed businesses of all sizes to more rapidly start and complete their digital transformation. More enterprises have been transitioning to the cloud, while many small and midsize businesses have begun to focus more on creating or improving their e-commerce sales channels. In addition, while the current downturn has had a devastating effect on small and midsize businesses, forcing many to shut down, many more are likely to be created during a recovery; those new companies are likely to focus initially more on e-commerce, which will require more digital ad spending. Further growth in e-commerce will also create opportunities for the direct-response ad inventory providers to also get a piece of the transactions conducted on their platforms. Plus, we think it is safe to assume that spending on broad-based campaigns will increase during a recovery. However, we still think advertisers will steadily shift focus toward direct-response types of marketing in the long run.

Facebook will be the main beneficiary of higher direct-response ad spending and the accelerated shift toward e-commerce. In addition, the increase in users and user engagement during the pandemic on Facebook and Instagram has created more ad inventory, which admittedly is currently being sold at lower prices. In our view, small and midsize businesses depend heavily on Facebook for their marketing, and we think this will remain the case in a recovery. We expect the recent launch of Facebook Shops will not only retain many small and midsize businesses that are advertising on the platform but also attract many new ones. The Instagram and Facebook checkout features also position the company to benefit from growth in e-commerce.

We have increased our 2020 top-line growth estimate for Facebook to 3% from a decline of 3% and now model a 21% five-year revenue compound annual growth rate, up from our previous 16% forecast. We continue to expect operating margins to be lower than historical levels, mainly due to additional costs of content quality management, which again has come to the forefront as some large brands and advertisers are suspending ad spending on Facebook and Instagram and demanding the company more effectively limit hate speech and misinformation.

While we don’t think the impact of such a boycott by advertisers on Facebook revenue will be significant, we remain concerned about the long-term risk of increased regulations. Facebook’s reaction to the boycott movement could lead various organizations and politicians to demand changes to Section 230 of the Communications Decency Act, which provides liability protection for online companies. As we have written, with Facebook further taking editorial control of content, it may be viewed in courts and by lawmakers as a publisher and not a distributor, possibly removing the protection of Section 230.

Regarding Alphabet, the significant cut in travel and hospitality ad spending probably put a bigger dent in its ad revenue than its peers’. On the other hand, we think that while some of the big brands are boycotting social media, some may spend more on search. In addition, we expect the lockdowns and quarantines to have increased viewership on YouTube, thereby increasing ad inventory. Similar to Facebook, while ad prices may have declined, increased volume will probably limit the impact of the pandemic on total ad revenue. We also think Google will be well positioned during a recovery to restart monetization efforts around Google Maps. As more small and midsize businesses begin to open up and more consumers spend more time outside their homes, demand for the app by advertisers and consumers should increase. Plus, as this downturn has pushed companies to speed up their overall digital transformation, especially when combined with the rise in working from home, growth in the company’s cloud revenue has accelerated. We now expect total Alphabet revenue growth of 4% in 2020, up from our initial 1% assumption. We assume a five-year 15% revenue compound annual growth rate, up from our previous 14% assumption.

While Pinterest and Snap may not have the best direct-response offerings (compared with Facebook), they continue to invest in improving those capabilities and have begun seeing some returns, as shown in their first-quarter results. For this reason, we think the two platforms will benefit more from the shift to direct-response spending than we initially expected. In addition, the companies have been targeted less by big brands and advertisers during the latest social media boycott movement. Users on both platforms are less likely to post hateful content, which means they could attract advertisers leaving Facebook and Twitter. Plus, both companies are likely to benefit from overall growth in e-commerce. Like Google, an economic recovery could boost monetization of Snap’s Snap Map. We think some of the features added to the app (as announced in June) will enhance the word-of-mouth marketing for many small and midsize businesses, possibly creating additional revenue.

For the reasons mentioned above, we increased our 2020 revenue growth assumptions for Pinterest to 9% from negative 1% and for Snap to 29% from 24%. We have maintained our 26% five-year revenue compound annual growth rate assumption for Pinterest and increased Snap’s by 1 percentage point to 29%.

While Twitter may be more affected by the downturn and the latest brand boycott, given its inferior direct-response offering, we think it will still benefit from higher overall digital ad spending. In addition, Twitter is in the process of improving its direct-response product, Mobile App Promotion. Plus, the company’s decision to not run any political ads could help bring more ad spending by large brands after the 2020 election. Twitter may be taking steps to create a subscription model, referred to as Gryphon, as reported by VentureBeat. While we expect only a fraction of Twitter’s users to be willing to pay for the service, the price could be high enough to match the ad model’s user monetization. Such a model may also create opportunities for professional content creators to create channels and monetize their content and bring them closer to their fans, similar to what Patreon and IAC’s Vimeo are doing. We have not made any assumptions regarding a subscription model in our projections for Twitter. We now look for a 1% revenue decline for Twitter in 2020 versus our previous assumption of a 6% decline. We have modeled an 11.5% five-year compound annual growth rate, higher than our previous 10% assumption.

Ali Mogharabi does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.