Facebook (FB) reported mixed 3Q18 results relative to expectations.  Revenues fell slightly short of estimates but operating and income and EPS beat consensus as the ramp in expenses to combat the many privacy issues the company is facing was slower than expected.  Management provided initial expense guidance for 2019 of up 40-50% indicating the 3Q18 positive surprise on expenses was likely timing related.

User metrics are equally important given overriding concern that all of the controversy surrounding FB will drive users and, ultimately, advertisers off the platform.  On this front, FB still saw about 8% user growth driven entirely by emerging markets.  North America saw flat growth on a year over basis and Europe had a slight decline related to recently new privacy regulations requiring users to opt in to FB data sharing.  One positive user metric showed stable engagement looking at daily vs monthly active users.

This set of results served to initially lead to a rally in FB shares after months of significant declines.  However, the stock is probing new 2018 lows today after a series of articles in the New York Times reignited controversy about how the company acted and what it said as the controversy that began with Russian election interference intensified.

After years of steady growth that was relative easy to forecast and model, FB has become difficult to analyze from a financial and strategic perspective.  The company is in transition as the main Facebook product shifts from being text based to stories.  Furthermore, FB is now more reliant on initial efforts to monetize the massively used but thus far ad-free Messenger and WhatsApp services.  On the financial side, it is not yet clear if advertisers will leave the platform or reduce their spending and with fresh controversies breaking, it is hard to gauge the level of operating expense required to fix the problems.

Following the report, earning estimates for 2019 fell about 8%, primarily on higher operating expense assumptions.  Currents consensus of $7.53 for 2019 is pretty close to Northlake’s initial simple model developed in July when the company’s 2Q18 earnings call dramatically lowered guidance-based on slower revenue growth and much higher expense growth.

We take comfort in the fact the street has finally moved its 2019 outlook in line with our more cautious view.  We believe estimates should stabilize now.  With the stock at less than 19 times 2019 estimates, we are willing to wait out the answer to the big questions surrounding user growth and advertiser loyalty.  The company’s platforms including Facebook, Instagram, Messenger, and WhatsApp still have massive reach and industry leading targeting capabilities.  It is up to management, damaged credibility and all, to directly address and fix the privacy issues.  Balancing out this likelihood vs. the cheap P-E ratio tells Northlake to sit tight for now.

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.