Since its IPO in May, Facebook (FB) stock has proven an exciting, albeit not so profitable ride. That is not to say that this stock will not prove to be profitable in the future, but with an astronomical PE ratio of more than 70 times earnings, it is difficult for the company to achieve such high expectations. With that in mind, the pressure is on for Facebook to continue growing revenue in a way that justifies the exceptionally high expectations of the stock. Lately, Facebook has made a number of changes that seem to be an obvious attempt to achieve exactly that, by gradually redefining the way it operates. I believe that this development is not only helpful, but essential to the short and long-term success of this company and its stock. With prices still well below its $38 IPO, Facebook has a long way to go to raise its stock to where investors would like it to be.
The most recent activity of Facebook that suggests a move in the right direction for the stock is the appearance of ads for Facebook on the gaming website, Zynga (ZNGA). Up until now, Facebook has limited its advertising to its own site. This attempt to expand serves as a major stepping stone in regards to the company's profitability and ultimately the upward mobility of the stock price for investors. This expansion for Facebook illustrates the potential of Facebook as an advertising network, moving beyond its social networking roots and gradually increasing the element of being an advertising network as well.
Right now, the progression seems to be limited to just Zynga.com, which is perhaps not that major of a leap, considering that, according to Morningstar.com:
90% of Zynga's revenues and bookings result from users playing games within the Facebook environment.
This being the case, Zynga appears to be more of an extension of Facebook than an entirely separate company. Indeed, there have been concerns expressed that Zynga is too reliant on Facebook for business, which Zynga seems to be addressing as it too attempts to change its image to instill more investor confidence. Regardless, the act of advertising for Facebook on Zynga seems suggestive of the intent to move toward greater exposure beyond Facebook's site itself, which, in my opinion, will be essential for the company to keep up with the expansion of the technology sector in the future.
Lets not forget that these ads are an expense for Facebook. The social website's expenses are growing rapidly. Facebook's first quarter revenue of $1.06 billion was down 6% from the previous quarter. The company cited "seasonal trends" in advertising as the culprit for this decline. Investors should keep in mind that many tech giants stumbled on higher than expected advertising costs in the past. For example, AOL, a $222 billion company back in December of 1999, is now worth a meager $2.6 billion.
Other tech companies involved in the advertising market, such as Google (GOOG), Amazon.com (AMZN) and Microsoft (MSFT) have been doing this for some time now, and it is about time that Facebook, often an industry leader in many aspects, catches up with its competitors' practice, which has already proven to be successful business practice. As Bloomberg points out, these companies have leveraged their experience in advertising to their advantage. Amazon.com uses customer-purchase data to design advertisements. Facebook will have to learn how to use its advantages fully in creating effective advertisements. The larger point being: it can be done.
Although Facebook expanding its marketing in this way is likely to have a positive effect on its revenue stream, it must be cautious about appearing to compromise the privacy of people using its site, which would ultimately prove to be a major hit to the stock's long term success. To counteract these concerns, Facebook has assured the public that it will not share any information about people or advertisers with Zynga. This is an ongoing issue for Facebook, and it must continue to grapple with this issue to maintain the confidence of its users and investors.
Other attempts to improve its marketing campaign include changes in personnel with new hires or promotions. Facebook has hired former Apple (AAPL) UI Design Manager, Chris Wheeldreyer, as its new product manager. This addition appears to be an attempt to bring in some new blood to reinvigorate the company and begin taking the next step as the company grows and evolves. Another recent change for Facebook is adding COO Sheryl Sandberg to the board of directors. Prior to this addition, the board was composed entirely of males.
As of last week, Facebook stock closed around $33 per share, showing an increase for the week, but ultimately, still down from an initial price offering that appears to have been overpriced. It is possible that these new developments with the greater emergence into the realm of advertisement marketing could have a substantial long-term positive effect on the price of Facebook's stock. However, this testing-the-waters approach with advertising is not the action that is going to forge the success of Facebook's stock in the future. Facebook is going to need to show real growth in its marketing activities as well as prove that the marketing can streamline its revenue and significantly enhance its bottom line.
I recommend monitoring the progress of Facebook closely over the coming weeks and potentially months. If, over the summer, it appears that Facebook advertisements are growing in prevalence and being seen on more and more websites throughout the web, there may very well be an excellent buying opportunity for investors to profit from and for Facebook to begin living up to the high expectations established during its initial public offering. The recent news that GM is back in talks with Facebook about advertising is a good sign, but Facebook will still have to prove it can be profitable.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.