Facebook (FB) reported 1Q20 sales slightly better than recently reduced expectations, and earnings in line with lowered estimates. Sales and earnings estimates fell roughly 6% and 11% respectively throughout March as analysts grappled with quantifying the challenges FB faced from the COVID crisis. Advertisers pulled back sharply in the final three weeks of March, but FB noted that ad sales growth in the first three weeks of April had recovered to a flat pace compared to last year. Investors reacted positively to the faster than expected bounce in growth in April, given 2Q20 is generally expected to bear the brunt of the damage from COVID for most companies and economies across the globe. Diversified ad verticals and strong engagement metrics were the primary drivers enabling FB to quickly return toward growth. The resiliency of the business through this challenging stretch demonstrates why FB remains a long-term winner. Northlake continues to see a near-term range of $200-$250, based upon 20x-25x $10 EPS, as a reasonable price for a high-quality growth business.

Digging into the details of the March slowdown and April recovery illustrate several important points about FB’s ad business. During the slowdown, FB still saw strong demand from video game and ecommerce advertisers, albeit at lower prices due to less participants overall in ad auctions. The relative stability of these ad verticals helped limit the damage during the slowdown and lead to a faster than expected initial recovery. The widely diversified exposure to small and medium businesses also proved beneficial, as these companies tend to focus more on direct response and ecommerce campaigns that are holding up better than large brand awareness campaigns common to TV and larger advertisers. FB remains a leader in ad product innovation, allowing advertisers to reach highly targeted audiences and directly measure the impact ads have on purchasing behavior. This encourages even the most cautious advertisers to spend at the right price given the visibility into the returns on ad investments. These characteristics allow FB to weather the storm better than most other businesses with cyclical economic exposure to areas like advertising, and will drive the return to prior levels of revenue growth when the economy begins to recover more broadly.

During the 1Q20 conference call, FB noted that voice and video calling doubled on Messenger and WhatsApp and message volume increased by 50%.  This higher engagement comes as everyone is practicing physical social distancing and finding new ways to digitally stay in touch with friends and family. Around 2.3 billion people used a FB product daily during the quarter, and 3 billion people used FB apps on a monthly basis. Broad reach and strong engagement are key drivers of success for FB by generating a massive supply of potential ad impressions for advertisers to buy.  As advertising demand normalizes over the coming quarters, elevated engagement with company’s family of apps should drive financial returns back to pre-COVID levels. Northlake believes it is likely that the increased engagement seen during the COVID crisis will become part of the new normal, expanding FB’s addressable audience and leading to even greater growth prospects.

FB is continuing to invest in innovation and community support throughout the crisis by developing new products and directly donating money to small businesses in need of assistance. Examples of product innovation include Messenger Rooms, company fundraisers, and gift cards. Messenger Rooms is a new way for friends to host video chats and stay in touch. Fundraisers and gift cards allow the community to support the businesses they care about to help get them to the other side of this crisis. FB sees direct donations to struggling small businesses as a way to ensure their diversified advertiser base remains intact. Even while continuing to invest, FB announced that they planned to reduce expenses overall in 2020 compared to previous expectations. Some of the expenses will return to normal in 2021, but FB remains focused on maintaining high profit margins over time to ensure the company can sustain its competitive position.

Longer term growth opportunities are also easy to see at FB. The core Facebook app, along with Messenger and Instagram, has a long runway toward maximizing revenue. Whatsapp remains an untapped opportunity, and the building blocks and engagement are coming into place for monetization to begin sooner than later. FB also recently announced a partnership with Jio Platforms in India, which will take advantage of the ecommerce and payment technologies FB has recently been developing. Each of these opportunities will come into play longer term, while FB should return to growth over the coming quarters as the COVID crisis eases. Furthermore, 2Q21 will likely be an extremely easy comparison, which will make growth look incredibly strong a year from now.

Put simply, FB has again demonstrated why it remains a long-term winner. Strong user engagement, a diversified advertiser base, and ongoing investments in product innovation are a recipe for continued success even in a challenging economic environment. While the stock is hovering near the lower end of our current price target range of $200-$250, Northlake expects the higher end of that range to come into play toward the end of 2020 as investors look to easy growth comparisons in 2021 and ongoing above average growth beyond that.

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.