4 Things Crucial to the Success of the Social Network King

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

Facebook (NASDAQ: FB) has not exactly performed well for its investors since going public a little over a year ago. Since its IPO priced at $38 per share, Facebook has been on a roller-coaster ride, and lately seems most comfortable in the $24-$29 range.

With the company set to release its second-quarter earnings on Wednesday, July 24, what should prospective and current investors be paying attention to, and should we consider getting in before the report?

Cash, and what Facebook plans to do with it

One area where Facebook has done right so far is its cash management. As of March, Facebook had about $9.5 billion in cash and investments on its balance sheet. What I want to know is what it intends to do with its cash. I expect that some will go to investments in new technologies and services, but I’m specifically listening for any clues about the future usage of its cash. 

How interested Facebook is in major M&A activity? Will it begin returning some cash to shareholders in the form of buybacks or dividends? While I don’t expect any major announcements in this regard, the conference call could provide some insight as to where the Facebook board may decide to allocate the pile of cash.

Gaming revenue

In the past couple of years, about 20% of Facebook’s revenue has come from gaming and the purchasing of “virtual goods” within those games. Zynga has been the primary source of this revenue, contributing about 15% of Facebook’s total revenue. There was some concern about Zynga venturing out on its own website, essentially cutting its ties with Facebook, but so far, these concerns seem unfounded. In fact, Facebook’s gaming revenue seems fine while Zynga hasn’t been doing so hot lately.

In June, Facebook gave the market a bit of insight into its current gaming revenue when it said that the first quarter of 2013 was its best gaming revenue quarter yet. The company also said that 82 of the top 100 grossing iOS game apps and 75 of the top 100 Android apps are integrated with Facebook.

A good example of the post-Zynga Facebook is the current top-grossing game, “Candy Crush Saga” by King, which ousted Zynga’s FarmVille 2 earlier this year. During this quarter’s report, I am very curious to see the actual numbers behind the company’s recent statements.

The ever-elusive monetization of mobile ads

While the big drop in the months following the IPO seemed to be the result of skepticism over the company’s ability to monetize mobile ads, it is starting to look like Facebook is winning that battle. According to a recent report, Facebook’s mobile ad revenue is expected to top $2 billion this year, up over 300% from 2012’s mobile revenue of less than $500 million.

Despite the increase, there is still a ton of growth potential in this area. Google (NASDAQ: GOOG) has done perhaps the best job of monetizing mobile ads so far, and is projected to earn $8.85 billion from mobile ads this year. Mobile ads are probably the most crucial revenue growth area for Facebook going forward, so any details on this are extremely important.

Competition – does it really matter?

There are several other relevant social networking companies out there, but my question is whether or not they matter to Facebook’s bottom line. 

LinkedIn (NYSE: LNKD) is the second-largest publicly-traded social networking company, but I don’t really see it as any threat to Facebook. While LinkedIn has been incredibly successful in building the world’s largest professional network of over 225 million members, I don’t see it as a viable “substitute” for Facebook, nor is it trying to be. 

LinkedIn is unique in that there is a "premium" membership option, for which users pay anywhere from $19.95-$74.95 per month for additional access to profiles as well as better search options. Forbes magazine has referred to LinkedIn as "the most advantageous social networking tool available to job seekers and business professionals today."

As an investment, however, I think LinkedIn has gone a little too far, too fast, trading at over 100 times even the most optimistic earnings expectations for the coming year. The company will report its earnings on Aug. 1, so be on the lookout for any surprises. If the company's current earnings (which are really not that important to the value of LinkedIn) come in below expectations, it could provide a more reasonable entry point. 

Google has been trying to capture social networking market share for some time now through its Google+ network, but in my opinion, it is  making one major mistake: it is trying to directly compete with Facebook.

Most of the reviews I read have nothing but good things to say about the site’s beauty and functionality. Google claims 190 million active members, and virtually all Google+ users are on Facebook more, simply because that’s where there friends are.

While I think Facebook is in a class of one, I’d be interested to hear anything the company has to say about Google’s new version.

Final thoughts

Facebook may be nearing maturity in terms of the number of users (well over 1 billion monthly), so now the focus is shifting away from growing and towards capitalizing on what it has. If I had to name one area that is absolutely crucial, it would be mobile ad revenue. If Facebook could get to even half of the mobile revenue of Google within the next couple of years, that would be a tremendously bullish sign for me, so I’m anxious to hear the company’s latest thoughts.

Regardless of what this quarter’s particular numbers turn out to be, Facebook is looking more like an excellent value play that is starting to get everything right.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Facebook, Google, and LinkedIn. The Motley Fool owns shares of Facebook, Google, and LinkedIn. 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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