Facebook's Future Success: An Avid User's Analysis

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

When Facebook (NASDAQ: FB) began trading on Friday May 18, 2012 the hype was immense. Yet when the stock opened at $38 it remained relatively constant and closed that Friday afternoon at $38.23. When the market opened on Monday May 21, 2012 the stock fell to $34.03 …and…well…most of you know the rest of the story; just picture Wiley Coyote chasing Road Runner and falling off the edge of a precipice. The stock price reached its lowest on September 4, 2012 at $17.73 a share, down 53.3% from its initial share price when it opened in May. It became clear that Facebook couldn’t only rely on its massive 1 billion user base to prompt investors into confidence. This meant Facebook had to generate more revenue from its user base.

Faced with the challenge of increasing revenue generated per user, Facebook has been improving since the end of 2011. Revenue ($3.711 billion) divided by number of users (845 million) for the end of 2011 was $4.39/user. At the end of 2012, revenue ($5.089 billion) divided by number of users (1.01 billion) equated to $5.04 per user. This indicates a few things to us investors. First, Facebook is taking active measures to increase the amount of revenue generated per user and that these measures are working. Additionally Facebook’s user base continues to increase at a consistently high rate. Despite this increase, Facebook has still managed to increase the revenue per user.

To manage increasing revenue, Facebook has implemented a number of money extracting features. The first money-maker is advertising. While advertising is not new for Facebook, the level of advertising is increasing. Advertising comprised 84% of total revenue in Q4 2012. Advertising revenue was up 41% since Q4 2011. Since Facebook’s user base has not risen 41%, this means that Facebook is making more money from advertising per user. As a personal Facebook user I have not been bothered by ads on Facebook when I am using my computer. Facebook could still increase advertisements without irritating and losing users.

However, advertisement has only been present on PC users, not mobile users. Thus, the bulk of their potential advertising revenue still remains untapped: Mobile DAUs (Daily active users). At the end of Q4 2012 (December 31, 2012) the number of mobile users had exceeded the amount of Web DAUs for the first time. The number of mobile users continues to grow. This has enormous implications for advertising revenue. Since explicit advertising on mobile Facebook has been non-existent, the majority of advertising revenue has come from web based Facebook. Thus, Facebook has the potential to double its advertising revenue in 2013 and 2014 if they exploit this user base.

However, I have one caveat for Facebook. Mobile devices often have small screens. The Facebook application takes up most of the screen and must remain compact to be enjoyable. Unlike Web Facebook with a large on-screen space, the amount of on-screen space for mobile Facebook is tiny. As a result a mobile ad placed on-screen will be much more noticeable, bothersome, and irritating than web based ads. If Facebook does implement mobile ads, it may decrease mobile DAUs. As the number of users switch from using Facebook on their computers to using Facebook on their mobile devices, the revenue generated by Web ads will become less and less. This current trend could spell out loss for Facebook if they do not tap into mobile advertising.

The other 16% of revenue for Facebook comes from a few other sources. Options like promoting posts, buying real gifts for friends, and purchasing fake items in video games (source of Zynga’s income) have been some other ways Facebook has increased revenue. These methods have been effective because they generate income without incurring on anyone's use of Facebook.

In summary, Facebook's revenue and user base continue to increase and they have taken some successful steps to increase revenue generated per user. The promoting post and gift for a friend have been revenue generating, low irritating ideas. Facebook needs to implement more of these types of ideas. Facebook invested $1.39 billion in R&D in 2012 and $896 million in Marketing in 2012 to perhaps develop some more of these ideas.

It seems Facebook is focusing on the long-term and is shying away from increasing advertisement in the short-term. This is a smart move. Think back to before 2010 with Myspace.com. The once bustling metropolis of social-connection crumbled in weeks and became ridden with flashing neon ads.  If Facebook ever decides to increase advertisement to the level myspace.com did, I would encourage all investors to abandon ship. However, it remains to be seen just what level of advertisement is appropriate to users. I believe Facebook is posing to insert advertisement to take advantage of their mobile MAUs without compromising their user base; how they do this will be instrumental to their success.

For Investors

It remains to be seen if Facebook will make good decisions in the coming months regarding advertising. Keep a lookout in the news for these decisions and keep a lookout on your own Facebook mobile apps. If the level of advertising becomes intolerable, sell. Focus, focus, focus on the way Facebook is advertising in both its mobile and web based applications. If Facebook continues on the track of increasing revenues and increasing users while maintaining a healthy level of advertising, hold onto your Facebook shares as long-term investments. If the advertising becomes irritating to the point of user loss, get out.



Fool blogger Kyle Goodwin does not own shares in any of the companies mentioned in this entry. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. 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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