Facebook’s Guidance Disappoints; Shares Not Yet Cheap

Facebook reported slightly mixed second-quarter results with revenue in line with our internal forecast but below consensus. It did beat expectations on the bottom line.

But Facebook’s guidance on margins trending to the mid-30s during the next couple of years as the company will be investing further in innovation, content creation, and data protection, was disappointing.

Total revenue growth was hampered by slower growth in monthly and daily active users due to the implementation of GDPR in Europe, which was partially offset by higher revenue generated per user. While margins remained at impressive levels, they did narrow year over year, as we had expected and noted in our previous reports. In light of the soft profitability guidance, we lowered our Facebook fair value estimate slightly to $186, from $198.

We’re still confident that wide-moat Facebook will successfully roll out new products for users and advertisers and the firm can continue to more effectively monetize its users as it begins to offer more premium video content not only on Facebook Watch but also on Instagram’s IGTV. Plus, we think Facebook will realize return on its investments in content quality management and data security in 2020 and beyond, resulting in longer-term margin expansion.

With the stock down about 20%, we now view shares as slightly undervalued when compared to our new $186 fair value estimate. But we do recommend waiting for a wider margin of safety, likely in the $150-$160 range, before investing in this wide-moat and high uncertainty name.