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The Armageddon That Never Happened

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It was supposed to be Armageddon. The stock was sure to hit rock bottom that day. Analysts had warned investors. The market sat cowering in fear. Many got their money out when they could. 804 million shares of Facebook (NASDAQ: FB) were about to hit the market like a ton of bricks.

Yet, in spite of all the new selling pressure from the lockup expiration, the stock went up. Way up. 12.6% to be exact. How could this be? Who’s buying up all these shares? Smart investors, that’s who. I believe, even with this 12.6% price injection the stock got, Facebook is a great long-term investment at this price.

Not So Many Shares After All

It’s quite possible that insiders elected not to sell most of the 804 million shares of their company on Wednesday. Since Facebook’s IPO at $38 in May, the stock price has fallen nearly 50%. Such low share prices likely discouraged many insiders from selling, as they believe Facebook really is the $100 billion company the IPO indicated.

The market was more than able to handle the amount of trading from the lockup expiration. A huge spike in the number of shares being traded actually sent shares up over 10% in early morning trading, as buyers were standing buy, perhaps waiting for the lockup to expire before jumping in.

Why Are People Buying?

Facebook is an advertising company. It collects data from people, and uses that information to send them ads. It’s a simple business model that works a lot like Google (NASDAQ: GOOG).

Seven months ago, when Facebook made its IPO, the company was not generating any revenue from its largest user base – mobile users. Over half of Facebook users access the website through their smartphones. With an inability to monetize those users, it’s no wonder the share price fell so quickly.

However, with its most recent earnings report, Facebook showed that its efforts in mobile were now starting to pay off. The company generated $153 million in mobile ad revenue, 14% of total advertising revenue last quarter. Sure, that’s still a bit disproportionate, but considering it was 0% just six months earlier, it’s a good sign things are moving in the right direction for Facebook.

The company did not release how much mobile advertising brought in during its second quarter, but analysts pegged it at about $45 million. They also believe that number was pretty close to $0 in the first quarter. I expect this phenomenal growth to continue, as Facebook CFO David Ebersman explained in the conference call that newsfeed ads are generating $4 million per day and 75% of that is now from mobile users. That’s over $250 million per quarter.

The biggest reason for Facebook’s success is that companies are simply making more money from Facebook ads. The click through rate (CTR) for advertisements on facebook.com improved 81% in Q3. The rate is double for mobile users compared to desktop users. This means more people are looking at advertisements on Facebook, thus the cost per click to advertisers is lower. Lower prices per viewer, mean advertisers realize a higher return on investment.

Facebook also developed a way to reduce the friction of turning an ad click into a sale by collecting credit card information from users and allowing them to make 1-click purchases. The company recently partnered with American Express (NYSE: AXP) to bring exclusive offers to users who sync their American Express information with their Facebook profile. The offers are just another form of advertising for Facebook.

While Facebook seems to have cracked the code on mobile advertising, Google continues to struggle. Google receives a price 40% to 50% lower on mobile ads compared to desktop ads. Meanwhile, Facebook receives a CPC 30% lower on mobile than on desktop, but makes up for it with 15 times the number of clicks. Comparatively, Google’s click through rate for mobile ads is between 1 and 3 times that of desktop ads.

Mobile is where the world is heading. The ability for Facebook to effectively monetize its mobile users is paramount to its success. I like the direction its heading, and with just nine months of focused effort on mobile the company has generated what appears to be a $1 billion annual revenue stream that should continue  to grow in the near future. The big lockup expiration ought to alleviate some of the selling pressure that the company has faced in the last month or so, and the stock is now free to climb higher.

Dig Deeper

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adamlevy has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and Google and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend American Express Company, Facebook, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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