Media Talk

Strong Growth and Expense Discipline Continue at Facebook

Facebook (FB) reported better than expected sales with profits significantly ahead of expectations. The strong results reflect expense discipline even as FB continues to invest for future growth. Looking ahead to the rest of this year, FB narrowed full year expense growth guidance from 40-50% to 40-45%. EPS easily beat Wall Street estimates even after accounting for a lower than expected tax rate.

User growth and engagement metrics remained strong for Facebook’s mobile News Feed and Instagram. Despite concerns around FB intentionally slowing ad load growth, ad impressions grew 19%, while the average price per ad grew 24%. A continued focus on improving ad measurement to determine the impact on consumer purchase activity is helping FB justify higher ad prices.

In the near term, FB is investing in premium video content with the goal of diverting dollars from TV ad budgets. Competitors including Alphabet (GOOG/GOOGL), Twitter (TWTR), Amazon (AMZN), and Apple (AAPL) have also become increasingly focused on video in recent quarters. In the longer term, growth will be driven by monetizing Messenger followed by WhatsApp. While neither product has begun to make significant contributions so far, we expect both products will unlock significant upside over the coming years. The management team at FB has consistently demonstrated a patient and careful approach to monetizing each product while delivering superior sales and profit growth.

One key risk for FB will eventually be managing the transition to slower growth. When sales growth inevitably decelerates in the coming years, expense discipline will be critical to maintain profitability while investing for innovation. It is important for investors to recognize this looming challenge and evaluate FB’s approach to the transition.

In summary, FB displays a superior growth outlook compared to almost any other company in today’s low growth environment. Additionally, at 33x 2017 estimated EPS with sales and EPS growth of 41% and 51%, respectively, valuation is not exceedingly high compared to the expected sales, EPS, and free cash flow per share growth in the range of 20-30% for the next few years. While FB currently trades at under 22x 2019 EPS of $7.98, we believe that the stock should trade above $200, equivalent to 25x 2019 EPS of $8 or above.

FB is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  FB is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

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