Facebook (FB) reported another strong quarter with EPS reaching 97 cents against estimates of 81 cents.  Revenue surprised to the upside by over $400mm, driving operating leverage as margins expanded by more almost 500 basis points.  User metrics were a little better than expected with daily and monthly active users still growing.  Given that 1.7 billion people are using FB at some point each month, maintaining user growth is impressive.  Ad revenue grew 63%, and acceleration from the last couple of quarter’s incredibly high rates. The big beat on EPS flows through to 2016 and 2017 estimates.  Next year should be comfortably north of $5.00, which leaves FB shares at a reasonable P-E of less than 25X even if growth slows to a range of 30-40%.  Northlake is sticking with its long positions in FB and looking for the shares to trade north of $150, maybe well north, in the next 12-18 months.

FB and GOOG are dominating internet advertising with about the only proven advertising models as far as return on investment for advertisers.  These two companies are akin to ABC, CBS, and NBC back before FOX and cable TV.  Massive reach and arguably the only way to reach a certain audiences gives them unusual power to drive ad revenues.  FB’s competitive position is further enhanced by its ability to narrowly target ads to specific demographics.  The recent shift toward video on FB should also drive growth as a new area for volume and at the typical higher CPMs for video ads.  Put it all together and you have user growth, new advertisers, larger ad budgets form existing advertisers, and rising CPMs.   Instagram is still ramping and while not yet being monetized What’s App and Messenger are massing user growth.

One area we think the street may be under appreciating is the potential for margin expansion.  58% operating margins are already quite high but given economies of scale and expense growth related to businesses that are not yet being monetized, further operating leverage could be material.

Put it all together and FB should sustain 40% growth in 2017 making the P-E of less than 25X quite attractive.

Areas of risk to watch include slowing engagement with the core platform among millennials given the rise of Snapchat, flattening ad loads as the company works to keep the services clean and not alienating users, and the inevitable tough comps especially as 4Q approaches when growth in 2015 picked up to 55-60%.

Concerns about FB being in a period of “peak growth” caused the stock to give up its initial gains as Wall Street is all about momentum these days.  Northlake is wary of slowing growth as we have seen that stall performance of other stocks but out time horizon is more than a days or weeks and FB remains in a dominant position.

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.