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Facebook’s well-publicized data breaches have resulted in a stock price that has declined over 25% since late July. So what should an investor do? John Archer, one of my managers, says Facebook is undervalued by over 20%.

Ken Kam: Why are you confident that Facebook is undervalued?

John Archer: Facebook’s financial fundamentals are incredibly strong. It has $42 billion in cash and marketable securities, no debt and superior cash flow. This gives the firm great financial flexibility to make its competitive position even stronger. Yes, the company will be pouring billions into the security of its platform, but I believe this will strengthen the barriers to entry for other competing platforms and give its users a greater sense of safety to share information with family and friends across the platform.

Kam: What does Facebook have to do to be worth more than it is now?

Archer: Facebook has the largest and one of the “stickiest” user bases in the world. It’s ability to keep and attract users is paramount to its future success coupled with its ability to provide advertisers the data required to target customers most efficiently. Its huge daily and monthly user base is an advertiser’s dream, and its ability to utilize the data of its users to help advertisers is a powerful tool that advertisers will pay for.

Facebook’s value will increase as they steadily increase the average revenue per user in future years.

Kam: If Facebook’s data breach and privacy issues were resolved, what do you think Facebook is worth?

Archer: It is important for investors to consider the difference between price vs. value. Price is what you pay. Value is what you get.

My current estimate of Facebook’s intrinsic value is between $175 and $250 per share (roughly $215 at the midpoint) which means it is currently undervalued by over 20%.

Kam: Are you buying the stock now, or waiting for a better price?

Archer: I would not be surprised to see the stock at these levels until it becomes evident that the platform is safer for the billions of people that use Facebook every month.

The stock price may be under pressure as the company’s increased spending reduces its margins and profitability. But, longer-term (5+ years) I think Facebook has a bright future.

My Take: Facebook blindsided investors last quarter with lower operating margin guidance for the next couple of years.

The CEO said “we’re investing so much in security that it will significantly impact our profitability.”

In 2017, Facebook’s operating margins were 50%. Even if operating margins were to come down to 35%, Facebook would still be more profitable than Google or Apple  whose operating margins are in the mid to low 20’s.

When there is bad news many investors shoot first and ask questions later (if ever). Facebook has been hit with a string of bad news and it has taken a toll on its stock.

If you can make a five year investment, this is a good time to buy Facebook.

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