Facebook (FB) has had a rough go lately.  News stories have occurred almost daily criticizing the company.  Politicians and regulators are looking for a way to punish the company and limit its influence.  Apple’s changes to enable greater privacy for iOS users is limiting FB’s ability to measure and target its users on behalf of advertisers.  The company is also not immune to macro factors such as supply chain issues, pull forward of digital economies, and tough comparisons.  Against this backdrop and a stock price that had declined about 15% since its all-time high in early September, FB reported 3Q21 results.  The results and guidance were disappointing by the company’s extremely high historical standards but not as bad as feared.  Management addressed the many issues swirling around the company proactively, and in Northlake’s opinion, effectively.  Overall, the quarterly report and conference call raised new questions for FB shares but also set the stage for improved performance in the quarters ahead.  The big question for Northlake is how much time it takes for the financial results to stabilize and re-accelerate.  We intend to wait.

Stock Reaction: The initial after-hours reaction to the results was positive and the shares opened higher.  This reaction was based on the results and guidance being no worse than already lowered expectations.  The stock quickly turned negative in morning trading and was down about 5% in the afternoon.  The shift in tone is most likely based on the materially lower estimates for 2022 and the realization that it could be several quarters before results stabilize and improve.

Earnings Analysis: Revenue fell slightly short of estimates but grew 35%.  Operating income was also a little shy of estimates as margins fell due to higher expenses to both combat the near-term issues and support the company’s investments for the long-term.  Guidance calls for a continued deceleration of revenue growth due to Apple privacy, tougher comparisons for ecommerce and digital ad comparisons, and an assumed slowing in advertising as supply chain challenges leave many businesses without enough inventory to meet demand.  Encouragingly, management noted that it was about hallway done with changes meant to bring measurement and targeting back to previous levels.  Facebook seems well ahead of peers in this area, but it remains unclear how much “signaling” will be permanently lost for advertisers.  Apple’s changes effectively require a shift for advertisers from targeting individual users to similar groups.  For now, advertisers are not able to target potential customers as specifically or measure the effectiveness of the ads.  Eventually, Northlake believes FB will be able to mostly solve these problems even if not achieve earlier return on investment for its advertisers.  One thing working in the company’s favor is that all digital advertisers face the same issues and FB should emerge maintaining its status as the best place and highest return for advertisers.  We all hate advertisements but the reality is they work and competition means businesses will spend to maintain and grow market share.

Target Price: We believe investors should be patient with FB shares, even if it takes several quarters to resume the uptrend.  Looking out into mid-2022, we have established a target price of $365.  This is only down slightly from our prior target of $375.  However, we have lost a year of time value.  We are using materially lower estimates for 2022, while 2023 comes down as well but to a much lesser extent.  Given the uncertainties and bad publicity we have also lowered the multiple of earnings and/or EBITDA we use to value the shares.  We strongly suspect our new estimates and target price will prove conservative.  The shares will start moving upward again when it becomes clear that growth will again accelerate and estimates for out years rise.  This could take several quarters or maybe less if the mitigation efforts on privacy start showing results.

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.  DIS is a net long position in the Entermedia Funds.