Facebook analyst explains why he downgraded the stock, preceding its slide

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The Facebook analyst who downgraded the stock Tuesday told CNBC he is concerned about the growth of the social media giant’s advertising business.

In particular, Pivotal Research Group analyst Michael Levine said he believes a slowdown in advertising from direct-to-consumer brands could spell bad news for Facebook. Instagram and Facebook are the most popular places to advertise for those companies, he said.

“We’re just looking at the sign posts that have been popping up over the last few months, and it just feels very unsustainable,” he said on “Power Lunch.”

Shares of Facebook closed down 2.76% at $207.19 on Tuesday following Pivotal’s downgrade to sell from hold.

News also surfaced that Facebook and other large tech rivals are facing additional scrutiny around smaller acquisitions from the Federal Trade Commission.

Among the worrisome “sign posts” Levine referenced are changes to the way web browser Google Chrome allows companies to utilize small bits of third-party data known as cookies.

Those changes, paired with Apple’s newest iOS software, could have “wide ramifications for the advertising ecosystem,” ultimately lowering return on investment for advertisers, Levine wrote in his note.

Levine said direct response advertisers — those that try to get people to act after seeing an ad, such as putting their name on an email list — are highly sensitive to return on investment. “If you’ve been paying $50 for a lead and all of a sudden that goes to $55, that’s a problem,” he said.

Spending on digital advertising has exploded in recent years, with revenue topping $100 billion for the first time in 2018. Facebook was expected to claim more than 20% of digital ad revenues by the end of last year, according to eMarketer.

Levine reduced his price target on the stock from $215 to $180. On Jan. 30, Levine lowered his price target to $215 from $245 while downgrading it to hold from buy.

In addition to concerns about advertising growth, Levine also cited regulatory threats as a reason for his sell call.

“We are nervous that the next update we are going to receive will be about an FTC/DOJ case seeking a breakup of the company,” Levine wrote.

Long-term investors would be better served in the stocks of Amazon and Google “as we think the overhangs are likely to persist” with Facebook, Levine wrote.

Levine noted he is not the only one raising concerns about advertising challenges for Facebook, pointing to CFO David Wehner’s comments during the company’s latest earnings call.

“We are seeing headwinds in terms of targeting and measurement, but as I noted, the majority that impact lies in front of us,” Wehner said, according to a transcript of the call.

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