Facebook continues to perform well despite the economic impact of the pandemic and negative publicity surrounding privacy and political issues.  Ad revenue grew 22% during 3Q20, powering a better than expected earnings report.  This is the second consecutive quarter that Facebook had better than expected advertising growth, supporting the idea that it is a COVID winner.  Revenue accelerated through the quarter as July was up 10%.  Management guided 4Q20 ad revenue to be ahead of the 3Q20 growth rate.  Strong revenue growth was accompanied by expanding operating margins, a good sign given that expense growth has been an issue for Facebook since the Cambridge Analytica scandal forced the company to spend a lot more on privacy.  With revenues and profit margins coming in better than expected, EPS easily exceeded analyst estimates.

Usually, an earnings report this solid would lead to a nice pop in the share price.  However, management spoiled the party by giving guidance for 2021 operating expense to be well above Wall Street expectations.  The company has usually easily spent toward the low end or under its preliminary guidance for operating expenses.  Thus, it is probably safe to assume this will be a conservative forecast.  It does still raise some concerns, however, due to management continuing to point out that 2021 revenue growth could face some unusual headwinds.  Management has mentioned changes to Apple’s privacy rules, European regulation, and the possibility that 2020 COVID driven growth is pulling forward ecommerce growth.  Most likely, management just wants to keep 2021 top line estimates under control given the impressive growth in 2020 during the pandemic.

Northlake continues to look favorably on Facebook shares.  Compared to other large internet companies, we think Facebook has a very large revenue opportunity on compared to its current scale.  The powerful family of apps includes Facebook, Instagram, Messenger, and WhatsApp.  The last two are barely monetized today despite having massive global scale.  Instagram remains early in its growth curve and, along with Facebook, increasingly targets ecommerce and the benefit that ecommerce has on core advertising revenue.  Despite its massive size today, Facebook still has a large growth opportunity and the ability to sustain 20%+ top line growth for years to come.  Furthermore, after several years of elevated operating expense growth, beyond 2021 margins should stabilize or expand. 

For a company the size of Facebook, the ability to drive 20% growth in revenue and earnings is rare.  At 25 times 2021 consensus EPS estimates, Facebook shares trade at only a small premium to the market. We think continued positive earnings surprises can push the stock back to new highs above $300 in the months ahead.  As we move deeper into 2021 and investors begin to value the shares on 2022 earnings, a move to $325 is reasonable providing upside of over 20% in the year ahead.  This is a more optimistic outlook than we had for FB shares following 2Q results.  Our improved outlook has been well earned given the great performance of the company through the COVID crisis.

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.