Time to Buy Facebook?

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

I've been one of the bigger Facebook (NASDAQ: FB) skeptics from the beginning of the company's public trading life. Though several years ago the stock would've been an incredible value, I've written in the past that I'm not convinced that waiting until the company had nearly 1 billion users was the right timing to go public. Clearly the market has agreed with my thesis, and the stock is still down tremendously from its IPO pricing. That being said, it doesn't pay to look in the rearview mirror for too long. The company is taking some positive steps to address issues that users have had, and make its advertising more relevant. While these are improvements for users today, Facebook's future likely will take the company in a direction that many investors never anticipated.

The Problem With Banner Ads:

Facebook relies on advertising to make most of its money. In theory, any weakness in the advertising market, or in the relative value advertisers see in Facebook's model, would be a detriment to the company's future prospects. At this point, it really is less about how Facebook can gain more users, and more about how Facebook can make more money off of its user base. In a recent video, Eric Bleeker of Fool.com mentioned a huge problem Facebook has when it comes to making money off of its advertising called “banner blindness.” Users have trained themselves to ignore advertising on a web page almost without thinking. In his video, Eric says that Facebook is beginning to allow advertisers to match user's email and phone numbers to their contact lists. It makes sense that an advertiser would want to start with an individual who has already shown interest in their product or service, rather than trying to attract uninvolved prospects. While this is a step in the right direction, all this does is utilizes a small amount of information that Facebook already has on file. In order for the company to transform its advertising, it needs to make better use of its in-line advertising. This advertising is posted within a user's news feed instead of on a separate part of the page.

In-Line Advertising:

There are two huge advantages to in-line advertising versus more traditional banner ads. First, users concentrate on their newsfeed, by placing advertisements within this part of the site they are likely to get more attention. Second, in-line advertising works on both the desktop and mobile platforms equally well. In fact, I believe in-line advertising is the answer to how Facebook can monetize mobile. The company serves up two different types of in-line ads. One is an advertisement based on what my Facebook friends “like.” This is a targeted ad showing more information about just one product or service. The second type of ad is less about advertising and more about collecting information. This ad shows three product or service pages on Facebook and which of my friends “like” each one. This gives the user the option of “liking” things that they might not have given consideration to. Facebook gains valuable information for each new product or service a user likes. These two types of in-line advertising are acceptable in the user's newsfeed as long as Facebook doesn't allow these ads to overwhelm the site.

Search is The Future:

In an article by Evan Niu on Fool.com, he talked about some of the comments Zuckerberg made at the previously mentioned conference. The headline that every investor should be aware of is, the comment that Facebook is already working on a solution for web search. Evan pointed out that Facebook is already running about 1 billion searches a day, with users looking for people and company pages on the site. In fact, the company has changed its search bar from saying “search for people” to saying “search for people, places and things.” In addition, the company already offers web search results and it would just be a case of tweaking the search bar to make these more prominent. For instance, I typed in Coca-Cola to see what would come up. The drop down results showed the “top 8” results for different Facebook pages related to Coca-Cola. There is a link at the bottom of this “top 8” that says “see more results for Coca-Cola”.

When you click on the “see more” link you get a page with the Facebook links at the top, “Posts by Friends” next and then “Search the Web” powered by Microsoft's (NASDAQ: MSFT) Bing search engine. This web search is so integrated, that a click takes you to Bing results for Coca-Cola, but still inside the Facebook page. If there has ever been a threat to Google (NASDAQ: GOOG) that holds more promise, I'm not aware of it.

Mark Zuckerberg seems to be showing his hand in his comments about search, and there are clear winners and losers in this battle. Microsoft is the current winner aside from Facebook and there couldn't be a more obvious potential loser than Google. At last count, Google powers roughly 66% of domestic search results, with Bing and Yahoo! falling far behind. Until recently, most people would not have even listed Facebook as a potential competitor, but with this development Google needs to come up with a game plan to combat this potential threat. If investors are looking for a good reason that Facebook might be a buy even at today's prices, the company's potential in web search is that reason.

While Facebook is still clearly selling at a premium to its potential growth rate, this premium has shrunk as the stock price has dropped. With shares trading today for about 35 times next year's earnings estimates, and analyst calling for over 27% earnings growth, the stock isn't as pricey as it once was. If the company can capitalize on the potential for search as another part of the site's core competencies, this would be a huge win for Zuckerberg, Facebook, and shareholders.

Conclusion:

With over 1 billion monthly active users and better in-line advertising, Facebook is better positioned to capitalize on its advertising potential. The potential for Facebook in search is a potentially game changing event. Search has always been an easy win for Google because the company could charge for advertisers placement in search results. If Facebook can capitalize on this opportunity, the company can diversify its revenue stream and truly transform the way many people use the Internet. Imagine going online, signing into Facebook, and being able to interact with your friends and search the web all from one place. While Facebook as a destination social networking site didn't impress me that much, a one stop shop for search and networking is a whole different ballgame.

Interested in Learning More?

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tMHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook, Google, and Microsoft and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend 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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