Ad Revenues Ignite Growth For Facebook

| About: Facebook (FB)

If Facebook (NASDAQ:FB) told you to jump off a cliff, would you do it? You just might. And it's this blind confidence and leap of faith that investors are looking to make this week as Facebook goes public. With current financial projections for the social media giant riding on future advertising and mobile growth, it's a little daunting to note that the core numbers in play are all being made in a haze. Let's start with a quick fact that is not too hazy - Facebook relies on ad sales for 85% of its $3.71 billion in annual revenue.

To get a better feel for the overall social advertising world we are playing with, we can look at some recent results. As of October 2011, social networking websites received just 14.8% of all estimated display ad spending, according to comScore. There is a major opportunity for growth here, which is why the "Big F" likes to forecast the future with such gusto. There is no doubt that the social advertising marketplace is going to continue to gain more traction, but how far and how fast this traction occurs is up in the air.

While 84% of North American execs in a new eMarketer study believe social-media campaigns increased marketing effectiveness and sales efforts, over 50% believe the lack of a standardized metric that can measure a return on investment remains a major obstacle. Facebook reported a 37% year-over-year leap in ad revenue to $872 million in the first quarter, but a 7.5% decline sequentially due to "seasonal trends" and shifting user growth. Savvy investors never like to see the term "shifting user growth" as they prepare to throw money at a conceivably over-priced IPO.

Once you strip out the payments Facebook is receiving from app makers like Zynga (NASDAQ:ZNGA), the rate of ad revenue growth is eerily close to Google-but from a much smaller base, and it's declining. From the quarter ended in September 2011 to the quarter ended December 2011, it fell 33.3% to 44%. From December to March, it fell 7.1% to 36.9%.

Let us be clear, advertising ROI has always been a little fuzzy and always will be. We can all make educated guesses based on simple metrics like television viewership, magazine subscriptions, website traffic and more - yet they all lend themselves to scrutiny. In the digital advertising space, Google (NASDAQ:GOOG) has gotten much better at qualifying and quantifying sponsored links that get clicked leading to product sales, but at large, social advertising is still in its maturation stage.

We know that Facebook is ramping up for an $86+ billion IPO, yet we don't really know what the actual dollar value is for the ever-popular Facebook "Like." Advertisers live for Facebook "comments" and "shares," yet how can you put a dollar value on each action?

According to a study by eMarketer, for 47% of people, there's no value in a like, while 41% said they were somewhat more likely to purchase and 13% said they were much more likely to purchase.

According to Buddy Media, a social media advertising company, recent data shows that every share on Facebook generates an average of $2.10 in incremental sales. Ticketmaster has reported that every time a user posted on their news feed that they just bought a ticket from Ticketmaster, friends would then go on to spend an additional $5.30 on the site. According to Facebook's roadshow, Ben & Jerry's is getting back $3 for every $1 spent on Facebook.

The reason that Facebook, Google and throngs of vendors like Buddy Media are so leveraged to social advertising is simple. The number one trusted source of information for consumers is recommendations from friends and family. Facebook is currently the leading platform assembled to take absolute advantage of this truth.

For any company hoping to rule the digital lifestyle, the key is mobile. In March, the average Facebook mobile user engaged with the social network for more than 7 hours, according to comScore. Facebook is "just getting started" with its mobile app, said Zuckerberg, who explained last week at an investor event that as Facebook collects more data, such as location and which friends "like" certain products, mobile ads will be better targeted to users. One in seven overall minutes spent online are spent on Facebook, estimates comScore.

Facebook has a slew of advertising characteristics that support the enormous potential its valuation implies as we near the forecast opening day IPO share price of $35. It certainly starts with the brand's thriving pool of 900+ million users. These users love to interact with their friends, family and favorite brands.

There is no doubt that Facebook is primed for explosive growth into the foreseeable future, but let's remember one final fact: The internet lives and breathes with the daily, 24/7 creation of fresh, compelling content. If Facebook loses sight of the power of authentic content in exchange for more "sponsored stories" and sneaky ads, the company could get into some big trouble and so could its shareholders.

For the risk-lovers in the crowd, there's an interesting company that operates adjacent to Facebook by connecting advertisers with content providers. While this is by no means an endorsement to buy - the company, IZEA (NASDAQ:IZEA), is certainly worth a quick peek. IZEA claims to be the world leader in social media sponsorships, operating multiple marketplaces including, WeReward, Sponsored Tweets and SocialSpark. Unlike banner ads and clickable keywords, IZEA connects advertisers with social media influencers, helping them monetize their social media presence with authentic content. With 300 million+ social media sponsorships under their belt and the world at large focused on social media advertising this week - this stock could see a Facebook-related bounce.

For social media stocks, investors should heed the risks and continue to pay attention to growth and profitability fundamentals. Although investors are likely to crowd into this new sub-sector, long-run valuations remain difficult to discern even for the best run discounted cash flow models.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.