Facebook (FB) will report its Q1 2013 earnings on May 1. We expect to see mobile advertising results improve driven by the company’s efforts to integrate ads into its mobile platform. We expect margins will be lighter as Facebook is hiring aggressively to support the development of a host of features including gifts, Graph Search, custom audience and app-install ads.
In addition to this, we expect solid growth in Facebook’s social commerce business, which refers to the purchase of goods and services online. It differs from traditional e-commerce due to its social network association including user interactions and inputs. We’ll also keep an eye out for any updates from the company regarding the success of Graph Search, which could potentially make the platform even more attractive for advertisers.
Mobile Advertising Ramp Up And User Base Expansion
For the last few quarters, Facebook has stepped up its efforts to improve its mobile monetization. The company saw the ad revenue contribution of its mobile platform increase from about 14% in Q3 2012 to 23% in Q4 2012.  We expect this figure to grow further in the first quarter for 2013. While this is helping sustain revenue growth, margins have shrunk as the company is incurring higher costs due to higher headcount and infrastructure related expenses.
Facebook has a tremendous opportunity to leverage its user data to better target advertisements as well as improve and fine tune the current ads. The number of ads within Facebook’s mobile feeds have increased significantly and better effectiveness is also driving the ad pricing up. For instance, the company launched a huge mobile advertising campaign for Wal-Mart (WMT) during the holiday season and around 50 million ads focusing on deals and discounts were rolled out to millions of Facebook users.
The company is also working on promoting "custom audience," which basically combines Facebook’s user data and advertisers’ customer data to increase the effectiveness of the ads with improved targeting. In addition to this, Facebook also launched app install ads in October 2012, which have seen tremendous success.
User Base Expansion
The expansion in Asia and Latin America will continue to drive Facebook’s user base growth leading to a higher number of ad impressions. The company’s overall revenue growth is almost solely related to this expansion currently and the growth in the number of ads as opposed to pricing. In fact, ad pricing suffered a 4% drop in Q4 2012, compared to the same period a year ago due to its expansion in emerging markets.  However in developed markets the company saw a significant improvement in pricing, and as Facebook matures, the overall growth rate will slow and the impact of the ad pricing change will be more visible on overall revenue growth.
More Color On Graph Search’s Rollout Needed
In January, Facebook unveiled its new Graph Search functionality that it expects to become one of the key features of its business in the future. However, the usability of Graph Search is restricted due to privacy of user data as well as inconsistent levels of activity across Facebook users. In order to make it successful and make money from it, Facebook will need to encourage users to frequently use the "like" feature as well as try to integrate some sponsored search links within the results of Graph Search. We’ll look forward to any color on the success of this new functionality.
Facebook also needs to make sure that its users use Graph Search as often as possible. To do this, the company will need to make the search results more meaningful. This can only be done by including a larger data sample. While Facebook may not tamper with the privacy aspect, which greatly limits the usage of Graph Search, it may certainly encourage its users to “rate” and “like” content on Facebook. Various companies and businesses will also have the incentive to encourage their customers to like their pages, promotions or products in order to appear prominently in Facebook’s graph search results.
Growth In Social Commerce
Facebook’s social commerce business earned close to $40 million in revenues last year. We expect the growth to remain sharp this quarter, but its impact will be small given the size of Facebook’s advertising business.
While e-commerce sales through social networking sites are still quite low, the overall market is expected to grow from $5 billion in 2011 to around $30 billion in 2015 according to eMarketer. We expect this number to continue to grow beyond 2015 as well. For the last few years, Facebook has become the preferred platform for brands and retailers to promote their products by getting users to “like” the brand page and share it with friends.
Going by this trend, buying a product on a social network would be the next logical step in the value chain for the retailers. However, moving toward social shopping will be a gradual process as users increasingly get comfortable with purchasing products based on their friends’ recommendations. This would effectively be a translation of real-world dynamics into the virtual world where socializing with friends goes hand-in-hand with shopping.
Our price estimate for Facebook stands at $24.75, implying a discount of about 5% to the market price.
Disclosure: No positions.