Facebook's Growth Strategy Going Forward

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

Mark Zuckerberg was hit by a bit of skepticism at the shareholder meeting on June 11, 2013. Mark Zuckerberg is transitioning Facebook (NASDAQ: FB) into primarily being a mobile-only platform. The CEO mentioned that audience interaction metrics improved by 50% as the company continues to introduce new features to mobile handsets. The problem that Facebook faces with mobile is the sheer lack of screen space on mobile devices, which makes it difficult for display-based ads to work.

Key takeaway

The young CEO believes that the company is still on the right track for long-term growth. Analysts are probably debating that, considering the recent failure of Facebook Home. Not to mention, the CEO stated that he is coming up with strategies to make display-based advertising more useful for mobile devices.

The company has increased its research and development spending by 871.5% since the IPO. I am going to speculate that Facebook’s rapid increase in research and development spending is because the company is trying to develop add-on services that can be enabled for a fee on its mobile platform.

Potential product strategy

The company’s attempt at a mobile operating system was laughable based on the raving negative reviews the Facebook Home application got. But then again, it wasn't easy to create a mobile operating system that was easy to use, differentiated enough to be unique, and still appeal to Facebook’s long-term business strategy.

I am willing to assume that Facebook is developing more advanced Instagram picture editing software that can be bought with a monthly subscription fee. That way, if users want more advanced picture editing effects, they can pay for them. This is more lucrative, as a monthly subscription on 1% of the 100 million users on Instagram would bring in more revenue than advertising a banner ad on a 4 inch screen. If Mark Zuckerberg is really serious about being a mobile-driven company, then Facebook will have to abandon the advertising business model in favor of selling add-on services that will be unique to its social network.

Some have speculated on the success of a Facebook marketplace, but I think Facebook has something better in mind, and is unwilling to reveal it. Facebook is currently searching for a silver bullet to increase the amount of revenue that it can generate from mobile services. Another idea that came to mind is a sponsored status message that will go out to every user with certain demographic data. For example, Facebook users may soon find status messages that come from companies that they do not follow. Companies may be forced to pay for sending out a status message to people who are not currently following them. After all, everyone checks Facebook news feed. So, this could be a potential alternative to monetizing banner ads on the side.

Other companies

Because we’re not exactly certain of Facebook’s growth strategy, it is smart to diversify. In fact, with technology stocks, you have to diversify.

I believe that Microsoft (NASDAQ: MSFT) is a compelling investment. The company will successfully launch the next generation console, and it is highly likely that the company will earn better gross margins than Sony. In the end, consumers will pay more for the device because a comparable gaming computer could cost substantially more, and we’re talking about a multi-year upgrade cycle, so there’s going to be plenty of pent-up demand.

Microsoft has a compelling mobile strategy, and I believe it will work. The company’s Windows 8 operating system was designed to acquaint users with the mobile experience. According to Piper Jaffray, 5% of teenagers are planning to make their next phone purchase a Windows Phone. Microsoft’s mobile and entertainment strategy is growing, which keeps me optimistic. Plus, the death of computers is way overblown.

Let’s be honest, traditional laptop and desktop computers are the best content production devices on Earth. The tablet and smartphone will not replace desktop and laptop computers any time soon. IDC projects that PC demand will stabilize at a 1.9% growth rate following 2014, and Meg Whitman (Hewlett-Packard’s CEO) believes that demand in computers should stabilize in 2014 due to an enterprise upgrade cycle in Windows XP PCs due to Microsoft no longer supporting that operating system. Currently, 40% of businesses still run Windows XP, meaning potential pent-up demand in computers is just around the corner.

Analysts anticipate Microsoft to grow earnings by around 8.74% on average over the next five years. The company could surprise analyst expectations if Windows Mobile license sales beat expectations. The company also has a 2.64% dividend, which is pretty healthy for a technology company.

Investors should also consider a position in Amazon (NASDAQ: AMZN). For the same amount of risk, Amazon has high growth businesses that are continuing to grow. Amazon is setting up its own application marketplace, meaning the company could generate substantial fees from digital content sales. The company is continuing to roll out a number of retail websites across the world. The company’s global retail strategy grew at a 16% rate in its most recent quarter (European sales sagged, but 16% growth in a deflating economy is still impressive). The company also expects substantial growth from Amazon Web Services (cloud), which grew by 47.3% year-over-year in the latest quarter.

Amazon anticipates 22%-26% revenue growth for the full-year. If conditions improve in Europe, the growth in sales could potentially accelerate. The company is focused on growing its capital expenditures in order to sustain its high growth rate. The company was able to grow operating cash by 39% for the most recent quarter, which implies that the company’s 49.7 price-to-cash ratio is reasonable.

Conclusion

I doubt Facebook is sitting on its hands. The company is investing aggressively, but the desired outcome is something we haven’t seen yet. The company hasn’t been able to break out of decelerating revenue growth, plus the rapidly rising costs of operating the business have been sinking the price of the stock since IPO. Because of this, investors should also diversify.

Microsoft is pretty much your safe-haven in technology, and Amazon is the alternative growth strategy. With Amazon, you have a business that churns out predictable amounts of revenue and cash flow growth. Jeff Bezos has two core businesses that operate at scale and generate substantial growth. With Facebook, you’re seeing product cannibalization (mobile hurts desktop ad-sales) and un-proven spending practices. If anything, Amazon is another worthy alternative.

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Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Facebook. The Motley Fool owns shares of Amazon.com, Facebook, and Microsoft. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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