Following Q2 2018 results, we increased our price target on the stock from $180 to $220, therefore we maintain our Hold recommendation.
This is mainly due to an expected increase in the forward multiple from 20x to 24x. The improvement in the forward multiple is a result of our improved confidence in global growth given the central bank’s intervention as well as to capture potential income streams which at the moment are not being reflected in our valuation (eg Libra) which could be a game changer for the group.
Earnings per share for the quarter were reported at $1.99 above market expectations of $1.88. The beat was a result from higher advertising revenue. Average revenue per user was reported at $7.05 compared to market expectation of $6.87.
The negative is that management reported an operating margin of 27% for Q2 19. But this includes the $2bn provision put aside for the FTC charge of $5bn (this has now been provisioned in full). If we had to add back the provision, the margin would be 39%. However, this is still lower than the 44% reported in Q2 2018.
Yet even as Facebook resolved one major federal probe, it disclosed the existence of another: an FTC antitrust review that the company said began in June. Any further fines will continue to put downward pressure on margins.
Our concern going forward is that the improvement in infrastructure with regards to consumer privacy could result in product development more costly & time consuming. This will result in lower margins going forward.
What’s reassuring is that the company has made significant progress in tackling problems it faced due to data privacy issues. While Facebook still has much work to do, management made it clear that it now feels more comfortable increasing its efforts around new products and experiences.
Libra
Libra is Facebook’s proposed digital currency which is expected to be launched in the first half of 2020. Despite recent government scrutiny, management reiterated its plans to help launch and support the Libra currency. Management plans to work closely with regulators to address concerns before the launch. Due to its uncertainty, we are not including it in our valuation model.
Risks
1) Slowing engagement, especially in younger demographics & more mature markets;
2) Currently at or near peak margins;
3) Slowing advertising load growth creates meaningful revenue deceleration;
4) Pause or slowdown in advertising revenue from TV or traditional media;
5) Competition for online and mobile advertising from Google and other online advertising companies;
6) Share structure and Mark Zuckerberg’s control; &
7) Worse than expected impact from regulatory changes.
Conclusion
We feel comfortable holding onto the shares at these levels and adding on in days of weakness. However, in order to continue to see strong momentum build in the share price, we need to see a turnaround in margins and a conclusion on the antitrust review which we do not expect to have anytime soon.
Disclaimer:
This article was issued by Kristian Camenzuli, investment manager at Calamatta Cuschieri. For more information visit, https://cc.com.mt/ The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.