Heaven hath no fury than a momentum stock scorned on the Nasdaq. This is exactly what happened when Facebook missed analyst revenue/user growth estimates and the shares plunged 20 per cent in the premarket on Wall Street.
It was ironic that Facebook was the only real "value" play among the FANG at 26 times estimates earnings, a huge discount to the stratospheric 140-150 times multiples commanded by Netflix and Amazon.
True, Instagram is simply not big enough to offset the user growth headwinds that slammed the world's biggest social network colossus. Not even the Cambridge Analytica data privacy scandal or the Congressional grilling of Mark Zuckerberg could be remotely as draconian a catalyst for a $122 billion market cap flameout as was the prospect of, heresy of heresies, slower user growth. I have never seen a sell-off as brutal as this on a mere revenue disappointment and traded Facebook multiple times in the premarket and regular trading. Yet there is no doubt that Facebook's growth outlook in 2018 has deteriorated, as management indicated on the earnings conference call. Europe's strict new data privacy laws reduced activity and user growth in the EU countries. Facebook is also a victim of the fake news backlash and Russian cyber-espionage in the American political system.
With 2.23 billion active monthly users, 90 per cent of advertising on its mobile platforms, with invaluable digital ecosystems like Instagram, Messenger and WhatsApp, Facebook is one of the most exciting technology companies Silicon Valley has ever spawned. While average daily users flatlined in US/Canada and declined 1 per cent in Europe, the fact remains that global average daily users increased 11 per cent since the second quarter of 2017.
Revenues missed the Street consensus by $100 million but still grew an amazing 42 per cent to $13.2 billion in the second quarter. The untold gigabytes of data created by Facebook users every day is history's most valuable real time consumer behaviour data set for global advertisers.
However, it is undeniable that strict data privacy laws like Europe's General Data Protection Regulation will limit data sharing by users and constrain Facebook's secular revenue growth rate as well as erode the value of its ad targeting algorithms. Apart from its core social network platform, Facebook owns three properties that have one billion users each in Messenger, WhatsApp and Instagram.
Video content, artificial intelligence, virtual reality, global markets and the digital transformation of entire industries/economies will sustain Facebook's growth curve. Any company that almost doubles headcount to 30,275 in only 12 months simply cannot be dismissed as an ex growth Cinderella, as Mr Market did to Facebook on Thursday. This is the reason I am long Facebook on a tactical position at 175 for a 200 target. Unlike Mr Market, I am simply not ready to "unfriend" Facebook, one of the most unique businesses ever created (in a Harvard College dorm room no less!) in the history of the human race.
Facebook's margins will decline in 2018 due to new investments in data security and privacy as well as the mathematical reality that Instagram, WhatsApp and Messenger are slower monetisation engines than the core social network's digital advertising platform. Management did its best in the conference call to be very conservative, even cautious on revenue growth prospects, the reason the frenzied selling is unquestionably overdone. Facebook now trades at 11 times forward Ebitda and at an 18 per cent valuation discount to Google, which has slower EPS growth rate and lower operating margins than the House of Zuck.
Wall Street analysts will incorporate these diminished expectations in their new revenue model. In retrospect, it was naïve for the capital markets to assume that the higher cost of regulatory compliance that Zuckerberg promised in his Congressional testimony as well as well as investments in new businesses would not have an impact on short-term financial performance. Management did not communicate this linkage in this first-quarter conference call, the reason for the sense of betrayal and scale of selling last week.
Facebook, a stock I first bought after its botched IPO at 20, is still one of the world's great technology driven media businesses. Its global brands and messaging technologies make it a compelling platform for the world's top digital advertisers. As I write, Facebook trades at 17 times earnings ex-cash. This is inexpensive for a media monetisation engine that can well deliver 30 per cent revenue and 25 per cent Ebitda growth next year. As in April, bad news is an ideal entry point for the shares.
By Matein Khalid
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