Facebook (FB) has certainly had a noisy entrance into the world of publicly held companies. Since its debut in the stock market, the obstacles the company faces have perhaps been trumpeted more loudly than the opportunities and potential it has ahead of it. The resultant halving of the share price since Facebook's IPO has left a sour taste in many investors' mouths. However, one has to wonder when enough is enough and begin to contemplate a price where initiating a position in FB is worthwhile if one believes that Facebook will eventually fulfill its potential and overcome the readily recognizable obstacles before it.
As there are two sides to every coin (even those coins lost in FB to date), there must be two sides to every investment prospect. I would not presume to say that FB is a phenomenal company with everything figured out at this point in its life, but I will be forthright in my belief that it does have some of the most phenomenal potential for future success. However, for Facebook to meet this potential, a number of obstacles must be converted into opportunities. This article is intended to revisit some of the reasons Facebook was once a symbol of high hopes, while maintaining a level of caution given headwinds it faces in the near term.
Obstacle: Monetizing Mobile Users
This is really the heart of the issue for Facebook. We've all heard the horror stories of how mass migration of internet users to mobile devices, such as smartphones and away from desktop screens, can be a profit-killing trend for internet advertising companies. Even the defending online advertisement champion, Google (GOOG), has voiced concerns in the past. Facebook has certainly acknowledged that as of now, it is not able to generate the same type of revenue from mobile users as it can from desktop users. The problem is a simple one - space - yet not an easy one to solve. It is a simple matter of less room for advertising on a smaller screen, which in turn obviously means lower ad volume and revenue.
Facebook's recent second quarter conference call shows us just how scary this issue can be. Management says that the number of overall ads delivered in the United States declined 2%, despite a 10% increase in daily users, and also noted similar trends in other developed markets. This decline in ads delivered is attributed to more Facebook usage on mobile devices, and is certainly not an encouraging statistic.
One could elaborate for an entire essay on the difficulties FB faces in mobile monetization, but to avoid beating a dead horse, suffice to say this is among the largest, if not the largest, of the headwinds facing Facebook at the moment. Having established this foundational thesis (which admittedly is a pretty bearish thesis for a Facebook optimist like myself), a well-rounded investor must objectively view the broader picture ahead of Facebook, placing emphasis on specific steps currently being taken to monetize mobile users as the trend to mobile FB usage continues at a rapid pace.
The basic concept the company is attempting to accomplish is the "socializing" of advertising. As CEO Mark Zuckerberg notes in the recent Q2 conference call, the "basic idea here is that the best type of advertising is a message from a friend." Management identifies one product in specific that will be the "cornerstone" of mobile monetization strategy for the remainder of 2012 and beyond: Sponsored Stories in the News Feed. Before we try to analyze the success so far with this product, I think it behooves us to analyze the theory behind this product. The following is a description of the product directly from the Q2 conference call transcript:
"Sponsored Stories are regular stories that people see in the News Feed already -Updates, likes, comments that are on Facebook every day that a marketer pays to highlight. For example, if I post a positive review of a product that's purchased at Wal-Mart, about 20% of my friends will see the post, depending on things like when they check their News Feed. Using Sponsored Stories, Wal-Mart can take a boost distribution of this post so that a larger percentage of my friends see it."
Opportunity: Monetizing Mobile via Sponsored Stories in the News Feed
So what is the benefit of this product more specifically? Well first of all, Sponsored Stories can be seamlessly integrated advertisement space, as the stories are already in the News Feed and are thus not overly intrusive or obnoxious. More directly addressing their benefit to monetizing mobile users, they do not require additional side-bar space to reach their targeted audience. Mobile users of Facebook spend the majority of their time scrolling through the News Feed anyway, and the News Feed experience is essentially identical on smart phone screen as it is on a laptop or desktop screen. So one can see how these Sponsored Stories help to circumvent the small screen problem. This is why management has noted that "Social Ads and News Feed give us a clear path to building a strong business on mobile," as outlined on the conference call. Management is attempting to make Facebook an enormous word-of-mouth machine.
I am more encouraged to see that FB is sticking to its main philosophy of socializing the world and never compromising on maintaining an optimal user experience. Many want to see immediate gratification with this company. However, FB is treading cautiously in rolling out these products to avoid alienating their users. After all, Facebook's roughly one billion users are the company's most important assets.
Management states that by the end of June 2012, Sponsored Stories in the News Feed were already bringing in over $1 million dollars per day in revenue, half of which was coming from mobile. Not a shabby start, though I will readily acknowledge this is not up to game changer levels for the stock price.
This is a start to the mobile monetization solution, and I would hope to see continued traction with this product in upcoming quarters. I am of the opinion that at minimum, this product demonstrates that the Facebook team is actively attacking this issue head on. I, for one, lean towards the belief that the Facebook team will figure this issue out in the long run. If and when they do, their potential addressable market is enormous.
Opportunity: Huge addressable market
At its fundamental level, Facebook is a veritable production mill for ad targetable data; the 'like' and 'want' buttons literally allow users to spread the word on products they like, and allow marketers to actively pursue interested consumers and create new interest in others as friends see what other friends are in to. All is not bad at the company. Ad pricing was up 9% in the most recent quarter, and the conference call demonstrates that Facebook is finally making headway in demonstrating a decent ROI on ads with Facebook.
I acknowledge that Facebook has many issues in the windshield right now. The expiration of lockups is still an overhang, even with Zuckerberg's agreement not to sell for one year. Mobile monetization will not happen overnight, and there is no hiding this fact. Even with the share price at half of the IPO price, the company is still very highly valued, with revenue growth not currently justifying valuation.
However, I believe that over the course of time, the company will come up with solutions to monetize mobile and demonstrate to marketers that it can create immense demand for products, leading to more ads at better prices for Facebook.
If you still have long-term faith in Facebook, my suggestion (and it is only a suggestion) is this: allow current obstacles to drag on share prices and nibble along the way down with wide scales. If you wish to invest in this company, begin buying small portions of your position as you are comfortable and buy increasingly larger portions on the way down until you have established the size position you desire. Then be patient, as management works to capitalize on the billions of ad targetable data points Facebook generates monthly.
I would not presume to conjecture a great entry price or future price target, but by averaging cost down in this manner, one can still attain a reasonable cost basis. However, I would blame no one for waiting until clearer signs of mobile monetization success, though by the time this becomes crystal clear, the stock may not have waited on us to join in!
These thoughts are, of course, my own opinions, and I would never recommend anyone make an investment decision without doing their own thorough homework to reach a well-balanced decision. I also welcome objective thoughts from bulls and bears alike for collegial discussion. Information included in this article is in large part found in the second quarter conference call and can be found in its entirety at this link.
Disclosure: I am long FB, with a small current position. I also intend to continue purchasing shares on any potential further substantial decline in the stock.