Investment Advisor Blog | Facebook Sell-Off Hard To Ignore From A Contrarian Perspective | Talkmarkets

Facebook Sell-Off Hard To Ignore From A Contrarian Perspective

Date: Tuesday, November 20, 2018 10:08 AM EDT

Shares of Facebook (FB) are dropping below $130 today as the high-flying tech sector continues a sharp correction in the market.

After such a punishing drop, it is hard for me to look away because there is a bullish fundamental story buried here, and the valuation is becoming quite undemanding.

From the business side, FB continues to offer a return on investment for small businesses that is unrivaled in the media industry. Couple that with a huge user base, that can make any successful new product launch (dating service, streaming TV, anything else they come up with later on, etc) inherently materially incremental to profits over the long term, and there are reasons to believe that the company’s business model is far from broken.

From a valuation perspective, investors are getting FB’s operations for about $113 per share (net of $14 per share of cash in the bank). With GAAP earnings of roughly$7 likely for 2018, and a path to EBITDA of $30 billion in 2019, the metrics look meager on both a trailing and forward basis, despite slowing growth and falling profit margins. I understand that FB is dealing with many operational challenges, but 16x trailing twelve-month earnings? 11x next year’s EBITDA, net of cash? At a certain point, the price more than reflects those challenges. It appears we have reached that point, so I cannot help but take notice.

There is still a bear case that deserves to be considered; namely that the business is permanently impaired and that revenue cannot continue to grow double digits. Essentially, the existing business is peaking and new offerings will fall flat (the new Portal hardware device?). Without growth, a near-market multiple would roughly be appropriate.

However, if the core story remains the same; rising revenue will be met with even-faster rising expenses, resulting in lower operating margins and slower profit growth, it appears the stock already more than reflects that outcome. Put another way, if GAAP earnings don’t stop at $7 and instead go to $8 in 2019 and $9 in 2020, etc, the stock is not going to stay in the 120’s for long.

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