We want to provide additional thoughts on Facebook (FB) following last night's earnings release which you can read about here. Shares are ripping today following what we believe to be a much needed "reset quarter" in which management gave a calm, level-headed and realistic view of the revenue and expense outlook. This posture removed a great deal of uncertainty that clouded over stock for the past three months. In response, we will upgrade our rating to a ONE and reiterate our $200 price target as we believe FB's worst is in the past.
Taking a step back for a moment, we initially downgraded shares to a Two back in March, here, noting, "We still like shares for the long-term as there is simply no social media alternative quite like Facebook, but the headlines risk right now is palpable. To better align our ratings with our commentary from Tuesday when we said we would look for the stock to break 18 times next year's earnings, or roughly $160 as an entry, we are downgrading shares to a TWO. We want members to know that our price level should be viewed as fluid given the developing storyline, and we will upgrade shares back to a One once we believe the top executives at Facebook instill confidence to the public and shareholders."
The third-quarter release, and more importantly management's commentary on the conference call, is exactly what we were looking for when we called upon management to "instill confidence to the public and shareholders," as it allows for a true bottom to begin to form due to a reset of future earnings expectations - a view we shared with members last night and one backed analyst revisions this morning - and provides a framework for investors to begin reassessing the fundamentals of the company based on its merit and not outsized growth expectations.
Moreover, we were highly encouraged by CEO Mark Zuckerberg's comments, where he noted, "Looking out beyond 2019, I know that we need to make sure our costs and revenue are better matched over time, and that's something that I'm focused on as well." We believe this to be exactly what investors wanted to hear, that costs growth peaked in 2018 and that management is refocusing their attention on margin performance. That said, management also controlled the narrative and investor expectations by being blunt in regard to future revenue growth and the transition to Stories, which they believe will take time to monetize as advertisers learn to work with the new medium but could ultimately become a bigger opportunity than today's "feed" based products, such as core Facebook. The point being, investors can now reset growth expectations and begin viewing FB as a value play with the potential for revenue growth reacceleration in the out years as Stories monetization increases and the team works to perfect its Video platform, which management noted has been held back on purpose in an effort to focus on the social aspects of the platform, rather than passive viewing, a factor that should help differentiate it from competitors like YouTube further down the line.
Finally, given today's move we want to note that while our upgrade is a reflection of our longer-term view, we want to reiterate today's commentary on Jim's Daily Rundown, where Jim notes that discipline would dictate waiting for a better price as we do not want to chase a stock, especially one that, at the time of this alert, is a top mover in the S&P 500.