Last April, I wrote an article called: "The Market's Misinterpretation of Facebook" which speculated that Facebook (NASDAQ:FB) was a significantly undervalued company with a tremendous amount of upside potential. Despite the naysayers who argued otherwise, the company has since leaped almost 100%. This article will address the company's progression as well as focalize on the direction the company is going in now as well as highlight the potential prospects and pitfalls of video ads, the possible expansion into Chinese markets, and the feasibility of Facebook becoming a search engine of its own.
In their second quarter, Facebook reported revenues of 1.8 billion ($200 million more than analysts' expectations) and the number of mobile users increased by 51% to 819 million year-over-year. In addition, more users than ever before have been utilizing the site and Facebook's monthly active users increased to 1.15 billion, a 21% increase year-over-year. In a recent press release, Mark Zuckerberg declared his intentions to expand Facebook's user base around the world and add more than a billion more users to the site within the coming years. If achieved, this ambitious new goal could double the stock price alone. Keeping that in mind, it is important to also note that Facebook has done an excellent job in monetizing itself over the course of the last twelve months and has been ambitiously planning the release of a potentially extremely profitable form of generating marketing revenue.
In recent months, Facebook has been on the cusp of completely implementing video ads into both Facebook and Instagram as a new form of generating supplementary ad revenue. If successfully implemented, Morgan Stanley financial analysts expect the company to generate $1 billion in video ad revenue within the first year of its implementation and as much as $6.5 Billion by 2020. The reason for this has to do with the site's demographic outreach, which caters to the 24-34 age group. Advertisers will pay premiums for their ads to be viewed by Facebook and Instagram users in this demographic due to the fact that current statistics evidence that advertising on T.V. networks is less effective nowadays. The problem that arises, however, is the implementation of video ads within the site, which many are currently fearful of. If the implementation of video Ads detract too much from the consumers' experience (i.e. they take over the screen and force users to watch them) then that would result in consumer frustration, which with web experiences can negatively affect user retention rates.
In order to emphasize the simplicity of how easily a site can be negatively affected by such a seemingly small change, let's take a look at the website Digg, which at one point was valued at over $160 million. Digg was a social bookmark site that was at one point one of the most viewed sites on the Internet. Prior to the explosion of sites such as Twitter and Facebook, Digg was utilized as a means of internet-based news sharing. However, due to a delay in the amount of time required to load a page (it was about a second or two) users became tired and began shifting to alternative news sites as a means of gaining information. In 2012, Digg was acquired for $500,000 and by then the website's user base had deteriorated dramatically. If there is anything to take away from the tale of the Digg website, it is that any interference with the user experience can often cause the user to reject the product. Therein lies the fundamental difficulty with implementing Video Ads into products such as Instagram and Facebook. Therefore, it will take time for video ads to be successfully implemented into Facebook before they will be as lucrative as analysts are predicting.
Expansion into China:
During Wednesday's trading session, Facebook hit an all-time high in its stock price after news was released that COO Sheryl Sandberg had met with China's Internet regulator Cai Mingzhao. Thus far speculators are predicting that the meeting between the two had less to do with opening up China to Facebook and more to do with opening up Chinese Advertisers to marketing on Facebook. If this happens to be the case, then the potential increase in Ad revenue could be anywhere from 500 million to more than a few billion. The reason why this would increase ad revenue is because it will allow industries in China to successfully market to ideal demographics in the United States as well as increase the potential for China to be more open to allowing Facebook to operate in the region. Either option, if successfully implemented, will signify massive revenue increases for Facebook. If tapped into, China could easily represent a user base of more than 500 million users. This is something to consider when individuals state that Facebook stock can't go any higher.
Turning Facebook Into A Search Engine:
As many already know, Facebook's "Graph Search" feature never took off as many had predicted it to do so. Keeping that in mind, Graph Search did open up the doors to a myriad of future possibilities. As Facebook expands its user experience, many predict that it is only a matter of time before they turn Facebook into a search engine of its own. In doing so, Facebook would take away market share from Google (NASDAQ:GOOG) as a means of generating billions of dollars of additional revenue. Signs of Google taking notice of this possibility are evident through the development, release, and failure of their own Social network, Google+. If users could stay on the same website and or browser through which they can see/interact with their friends and simultaneously surf the web, then that could make search engines such as Google obsolete. Obviously this is still speculative, but the possibility still remains.
With Facebook aggressively seeking to grow their monthly user base and diversify themselves internationally, the company seems to be taking the right approach to expansion. In addition, its caution in implementing video ads also bodes well as it displays a conscious awareness of their users "likes" and "dislikes." Ultimately the company is performing extremely well and has no direct competitors. That being said, I wouldn't be surprised to see Facebook continue to surge in coming months and believe it is still a valuable long-term play.
Of the forty-two analysts currently covering the company, more than 29 have ranked it a buy, 2 expect it to outperform and the remaining 11 believe it is a hold.
Disclosure: I am long FB. 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.