Facebook (FB) reported 3Q19 sales slightly ahead of expectations with stronger earnings driven by disciplined expense growth. Guidance commentary was mostly positive with a warning of a pronounced revenue deceleration in 4Q19 due to difficult comparisons to the prior year being offset by an encouraging outlook for 2020. Northlake sees FB heading toward a positive inflection for operating margins as the outsized expense growth required to address numerous challenges over the last few years begins to normalize to a rate below the pace of revenue growth. As FB nears this important milestone, earnings per share of $10+ move into striking distance implying a price target range of $200-$250.

FB still faces substantial challenges from intense regulatory scrutiny on many fronts. Following the footsteps of the EU General Data Protection Regulation (GDPR), lawmakers around the globe are exploring how best to protect the privacy of users’ data from misuse, which will remain a headwind for ad targeting, the related relevance of ads users see, and the prices FB can charge to serve those ads with a lessened ability to track ad effectiveness. The censorship or lack thereof on free speech and political ads – whether legitimate or designed to interfere – is a thorny issue with no easy solution in sight. Regulators and presidential candidates are also pushing for a fresh look at potentially anticompetitive behavior by large tech companies like FB. To investors, this all equates to elevated expense growth and fears the tech giants will be broken apart. Over the last few years, FB has consistently approached these challenges head leading to elevated expense growth.  Northlake believes expense growth should moderate in 2020 supporting our outlook for a positive margin inflection.

FB has continued to roll out new features and functionality across their suite of apps. 4Q18 saw the launch of some particularly popular features, leading to a challenging bar to clear in 4Q19. Beyond that, the outlook for 2020 is encouraging. FB has been investing in video content, partnering with news outlets, developing a dating service, implementing digital payments, and investing in many other areas to increase engagement and drive monetization. Investments supporting revenue growth are just as important as disciplined spending to address privacy challenges.

Northlake believes FB is on track to exceed investor expectations and surpass $10 EPS in the next couple years with sustained above-average growth to follow. Another way to put the $200-$250 price target range in context is to look at earnings estimates for 2023, where analysts see FB earning $15.93 per share. 25x 2023 EPS implies FB would be worth $398. If you buy FB today at $195, it would need to increase roughly 20% per year for the next four years to reach the 2023 target of $398. As long as FB continues to invest in an effective fashion to drive revenue growth and address regulatory items, Northlake sees substantial upside in the coming years.

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.