Did Facebook Inc. Become A 'Buy' After A Successful Quarter?

Jul.25.13 | About: Facebook (FB)

Facebook (NASDAQ:FB) is one of the most widely followed stocks in the world. Ever since its IPO, the company's share price saw a lot of volatility. On Wednesday evening, the company announced its results for the last quarter, which amazed many investors. Facebook reported a net income of 19 cents per share on revenue of $1.81 billion, whereas analysts were looking for 14 cents per share on $1.61 billion in revenues. Clearly, Facebook had a much better quarter than people were expecting it to.

Skepticism Proved Wrong

Until recently, many people were skeptical about Facebook's chances of generating sufficient money from its mobile applications. Because the usage in mobile applications has been increasing at a much faster rate than usage in PCs, many analysts and investors thought Facebook had a very limited amount of time to figure out how to make money on mobile applications before it would start posting huge losses. Recently, it looks as if Facebook has found a solution for the mobile problem, and it has found a way to successfully monetize its mobile applications.

As more than 500 million people log on to Facebook from their mobile phones every day, the number of mobile users passed the number of PC users for the first time. The ratio of daily actives to monthly actives was 61% in the last quarter (in the U.S., the ratio was as high as 70%), and this number is on the rise -- something very few people expected to happen. Facebook CEO Mark Zuckerberg also mentioned that on average, users of Facebook spend more time on the website compared to any other time since its inception. If people spend more time on Facebook, this will allow the company to obtain more advertisement since there will be more opportunities for advertisement exposure. This is interesting to note because many analysts were assuming that people would spend less time on Facebook since there are more alternatives to it (such as Twitter) at the moment.

Facebook Becoming a Contender

In the last quarter, Facebook launched Instagram Video, which is another product that directly competes with Google (NASDAQ:GOOG). It looks as if Facebook wants to be wherever Google is, and it will not leave any stones unturned. Google's YouTube has proven to be a huge success over the years as it made the company a lot of money. Back in 2006, Google paid $1.6 billion for YouTube, which currently generates 10% of the company's revenues. Keep in mind that Google generated $14 billion in revenues in the last quarter alone, which speaks volumes to YouTube's value. Can Facebook's Instagram Video become viable competition for YouTube? We don't know yet, but Zuckerberg was very happy about the early reactions of users to the product.

The last quarter was full of milestones for Facebook. One important milestone for the company was the fact that it passed 1 million advertisers (up from 500,000 last year) for the first time in its history. This is a huge number and is highly diversified in terms of industry, geography, and size. Facebook is doing a really good job of monetizing its content, and many people -- including me -- didn't expect it to do this well. With 18 million local businesses in its database, Facebook will be threatening companies like Yelp (NYSE:YELP) that have already been feeling the pressure. In the last few years, many small business owners complained about Yelp's treatment of their businesses and there are more than 700 FTC complaints regarding the company. If Yelp doesn't improve its relationship with local businesses, Facebook (along with Google Maps, which has been letting people post reviews on local businesses) will be there to eat Yelp's lunch.

It is a very difficult task to find the perfect balance between advertisement content and non-advertisement content in order to ensure the satisfaction of both members and advertisers. Currently, the ratio of advertisement content to non-advertisement content in the news feed is 1-to-20, meaning for every 20 news feed items, one will be an advertisement. Both sides seem to be happy with the current settings. In the future, as people's sentiments change, there can be some fine-tuning, but for the time being things are looking good.

Financial Results

In the quarter, Facebook generated $1.6 billion in advertisement revenues, which is up 61% since the same quarter last year. The mobile advertisement revenues make up 40% of this number, which is up from the 30% observed in the last quarter. Mobile advertisement revenues keep growing at an astonishing rate. In total, Facebook's quarterly revenue was $1.81 billion, up 54% since last year. At this rate, Facebook might become the next Google as every sixth person in the world is connected to it. Volume of advertisements was up 43%, while the price of each advertisement was up by 13% on average.

The company's gaming revenue was up by 11%, which is good news for investors in Zynga (NASDAQ:ZNGA) as the company is responsible for much of the Internet gaming related to social media. Zynga is set to announce earnings on Thursday, which should give us more information about the future of social media gaming.

As Facebook invested in infrastructure and new employees (headcount was up by 33%), the company's operating expenses jumped -- just like its revenues did. Facebook's total expenses were up by 54% and its operating income was $562 million. Excluding stock-based compensations, Facebook's operating margin was as high as 44%, which is quite impressive. The company's net income for the quarter was $488 million, translating into 19 cents per share.

In the next few days, we are going to see many analysts upgrading their future guidance figures and price targets. I expect there to be a lot of positive momentum behind Facebook, whose shares have been beaten down in the last few months due to many uncertainties regarding the company's business model. A lot of people were skeptical about Zuckerberg's execution capabilities, but he's been doing a great job so far. After all, he is the one who created this company from scratch and grew it to its current size. Perhaps people will give him more credit from now on.

Valuation and Conclusion

Facebook's current valuation is pretty high, but it's for a good reason: This is a high-growth company. Before earnings, analysts' average price target for the company was $33 per share and 24 out of the 29 analysts covering the stock had rated it either "strong buy" or "buy." There was no one who rated the company as either "underperform" or "sell."

Facebook's current P/E ratio is expected to fall to 67 by the end of this year, 45 by the end of 2014, and 30 by the end of 2015. As the company posted strong results on Wednesday, these numbers are likely to be updated in the next few days. In conclusion, Facebook is establishing itself as a serious contender and is moving toward becoming a decent investment.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FB over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.