Facebook (FB) has recently been the focus of media scrutiny surrounding the company’s role in Russian interference in the US presidential election, the Cambridge Analytica data leak, and the Eurozone’s upcoming General Data Protection Regulations (GDPR). Despite the concerns caused by these issues, FB reported impressive 1Q18 sales and earnings results. The outlook for 2018 year-over-year expense growth was narrowed from a range of 45-60% to 50-60% growth, signaling that FB has likely already accounted for most or all of the near-term expenses required to address data security. There was no discernable impact to user engagement metrics during the quarter. Northlake continues to expect FB to move toward $250 reflecting 25x 2019 EPS of $10.

Total advertising revenue grew 50% year-over-year, with mobile ad revenue growing an even more impressive 60%. The average price per ad increased 39% from 1Q17, slightly slower than the 43% growth in the previous quarter. Ad unit growth accelerated to 8% compared to 4% growth last quarter. The increase in ad volumes was partially due to the continued decrease in desktop usage; desktop users see more ads per page than mobile users, creating an easing headwind as the decline of desktop usage nears completion. The decline of desktop usage effectively masked the ad volume growth of mobile until now, but that impact is dissipating. Ad volumes also benefitted from strong growth in Instagram.

As noted earlier, FB narrowed 2018 expense guidance to a range of 50-60% growth compared to 2017. FB explained that the majority of the expenses driving the low end of guidance from 45% to 50% was related to security and safety, with other expense growth tied to video content and investments in technologies such as artificial intelligence (AI), augmented reality (AR), and virtual reality (VR). Ultimately, investments in AI should allow FB to scale back spending on employees to review safety and security issues but until AI is able to reliably handle such critical tasks, FB will continue to hire more employees.

FB’s daily and monthly active user metrics were not impacted in any noticeable way during the quarter. Given the fact that the Cambridge Analytica news broke near the end of 1Q18, investors would justifiably like to see another quarter with strong engagement metrics before concluding that the negative headlines had no impact on users. FB chose not to disclose changes to time spent on Facebook after noting it was down 5% last quarter amid changes to the newsfeed emphasizing friends and family over other content. FB is choosing to optimize the service based on quality of time spent on the platform rather than the time spent per user. CEO Mark Zuckerberg commented that FB conducted wellbeing research which demonstrated that meaningful digital interactions with family and friends have a positive effect compared to passive consumption of content. This should increase the value of the platform to advertisers.

Looking ahead, investors remain concerned about the upcoming implementation of GDPR and how it may affect FB ad targeting and measuring. If the vast majority of users elect not to share any data with FB, the company may be much less effective at matching advertisers with targeted customer groups and measuring the return on investment for advertisers. Targeting and measuring are two major advantages FB has over most advertising competitors. FB expects most people to continue to share data as the data is also used to improve the user experience in many ways. However, if GDPR does lead to consumers tightly protecting their data, the effects will be felt across the entire digital advertiser landscape. As long as FB is able to target and measure advertising relatively well compared to peers, the company should continue to take advertising market share.

In summary, Northlake sees a long runway for ad growth at FB. Only 7.5% of the 80 million businesses on Facebook advertise, and only 8% of the 25 million businesses on Instagram advertise. Messenger already has 18 million businesses on the platform and FB has moved slowly to monetize the app. Whatsapp remains a largely untapped opportunity. The number of businesses on each platform as well as the percent choosing to advertise should continue to grow rapidly. Further, as the transition from desktop to mobile nears completion, it is providing an unexpected further boost to ad unit growth. While expenses are growing rapidly, FB appears to have a handle on what is required for the short-term and long-term health of the business. We expect expense growth will peak in 2018 allowing the company’s margin profile to stabilize at still very healthy levels. Northlake expects FB shares to move towards $250 as visibility for $10 EPS in 2019 becomes clear.

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.