Facebook has faced a lingering storm of criticism from users, advertisers, and regulators over the past few months since the Cambridge Analytica data leak situation became public with Zuckerberg & Co. having to go on its Beltway and Brussels regulatory tour. While this has been the darkest chapter in Facebook’s 14-year history, based on our recent user and advertising checks we believe the company has seen minimal speed bumps in 2Q around advertising strength and user engagement trends which is a healthy sign looking ahead in our opinion for Facebook (and its investors). After a key 1Q earnings test in April which Facebook performed well while passing the regulatory hearings in both US and Europe with flying colors, now the focus for the Street is around 2Q as another “pivotal barometer” to gauge any fundamental damage (advertising, MAU growth) post the Cambridge situation. To this point, we believe 2Q is tracking to be a relatively strong quarter with modest upside to the Street’s estimates, while the investment profile for 2H18 might need to be ramped up further in light of increased security expenses. In a nutshell, overall this should be another step in the right direction for Facebook after a few months of navigating these unprecedented data concerns post the Cambridge debacle with the worries around regulatory headwinds and damage to the company’s advertising fortress a lingering cloud over the stock that has started to slowly dissipate. Based on our recent survey data, we believe less than 3% of Facebook’s revenues is potentially “at risk” for 2H18 based on slower user growth and advertising softness post Cambridge, however the “considerable strength” we are picking up from the Instagram side of the house (e.g. strong advertising and user growth) should help neutralize any of this potential weakness on the core platform in our opinion. In a nutshell, so far the fundamental damage to the Facebook platform has been “very contained” in our opinion and is much better than feared which is a relief for 2Q/2H18, however this will still be a long winding road that lies ahead for Facebook and Zuckerberg to help navigate the regulatory landscape both in the US and Europe over the next 18 to 24 months. We maintain our Highly Attractive rating and $225 price target.
MAU growth story remains the fuel; Instagram the golden jewel. With MAUs currently north of 2 billion total users, Facebook will continue to grow its massive global installed base in our opinion while importantly monetizing users especially on the Instagram side of the house, which remains the “core 1-2 punch” that underlies our bullish thesis on the name. We note that Instagram remains a “golden jewel” in Facebook’s advertising kingdom in our opinion with healthy monetization and ad growth set to play out for the rest of 2018/2019 and beyond based on our forecasts. With the Instagram platform now boasting 1 billion MAUs (up markedly from 800 million in September), we view this as an underappreciated asset by the Street that could be a major growth catalyst for Facebook over the next 12 to 18 months on the advertising front, helping neutralize some of the headwinds post Cambridge/News Feed overhaul. On another note, while the much-discussed News Feed changes recently implemented could be worrisome in terms of an ad growth hiccup in 2H, we continue to believe this overhaul was the right move for longer term user engagement and driving “meaningful content”, which remains the core ingredient in Facebook’s recipe for success for the coming years. We also believe this will reduce ad load and ultimately in late 2H18 enable Facebook to charge higher prices to advertisers once the dust settles from this News Feed change, a positive long-term driver in our opinion for the $50 billion per year advertising behemoth. Competitively speaking, we continue to tangentially believe based on data points that Twitter is the main beneficiary from some of these News Feed changes as this platform is seeing more advertisers now “dipping a toe” that have previously shunned advertising on Twitter for a myriad of reasons, a clear positive in our opinion for Dorsey & Co. in 2Q and beyond.