Facebook (FB) reported largely inline results in 2Q19 reinforcing that the company has weathered the storm surrounding the privacy issues that have plagued the stock since mid-2018.  Revenue growth has decelerated and expenses are higher as management has signaled.  However, in both cases the actual results have been better than expected from an investor perspective.  Revenues on a currency neutral basis grew 32% in 2Q19, ahead of consensus estimates of 28%.  Prior to the emergence of the Cambridge Analytica scandal, FB was growing the top line at 40-50%.  In summer of 2018, management forecast sharp deceleration in growth occurring on a sequential basis (each quarter growth slower than the last).  This has occurred but at a more moderate pace than expected.  Similarly, management guided to accelerated expense growth to deal with the privacy issues. Expenses have grown, generally by mid-to-upper 30% each quarter on a year-over-year basis.  But management had guided to expense growth of as much as 55% per year.  Put this together and FB earnings have held up much better than expected with better than feared revenue and operating expense growth.  At one point, we thought 2020 earnings for FB could be near $8.00.  They now look comfortably over $9.00 and possibly as high as $10.00.

On the 2Q19 conference call, management indicated that the sequential deceleration in revenue growth would continue into 2020.  This is a negative but given that the last several quarters have comfortably exceeded revenue growth guidance, management is probably being conservative.  Most analysts raised 2020 revenue in their models after the report and now show low-to-mid 20% growth.  Most also assume that expense growth decelerates further to match the level of revenue growth resulting in stable operating margins after two years of decline.  Should this occur, earnings in 2020 should reach $10+ and the stock could trade back to new highs in the mid-$200 range.

Northlake believes the odds of this are good.  However, the stock is probably due for a little pause as investors grapple with the new comments on revenue deceleration continuing into 2020 and the new Justice Department antitrust investigation.  Settlement with FTC, even with a $5 billion fine and new privacy requirements, is a modest positive as it frees FB to pursue innovation again, including its cryptocurrency play Libra.  Northlake plans to sit tight with FB as we believe the bull case of stabilizing margins and sustained revenue growth at least in the upper 20% range is most likely.

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.