Facebook Dismantles the Bear Thesis

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

I was a Facebook (NASDAQ: FB) skeptic. I didn't think the company would figure out mobile. I was concerned teenagers were dropping the network. I thought the stock's valuation looked a little stretched. But during the company's 40-minute conference call, all three pillars of my thesis were dismantled. 

Facebook cracked mobile

Facebook has figured out mobile, and the numbers are drool-inducing. Mobile advertising represented 41% of the company's $1.6 billion advertising revenue versus virtually nothing last year. Active mobile users were up 27%. Cost-per-click, or CPC, rates were up 41%. And all of this is funneling straight to the bottom-line because the company is doing a better job at controlling costs. 

In contrast, rival Google (NASDAQ: GOOG) is losing its mobile momentum. CPC rates were down 2%, representing the seventh straight quarterly decline.

Why this divergence? Facebook has several advantages in the mobile space.

First is how Facebook's large photo ads are inserted in the news feed of the mobile app. These ads look nearly identical to the content, blending everything together nicely. For advertisers it's a more compelling offer than Google's text based paid listings and small mobile banners. 

Second, Facebook's desktop and mobile ads look identical to each other, which makes it easier for advertisers to launch campaigns. This is unlike Google where differences between platforms create additional hassles. 

Zuckerberg is a long way from catching Google in mobile. According to eMarketer, Facebook accounted for 14.9% of U.S. mobile ad spending versus Google's 52.1%. But this quarter tells me Facebook could be on its way to taking a lot of market share. Larry Page look out!

Teens still friending Zuckerberg

There have been lots of reports that Facebook is losing its cool among the important teen demographic because of privacy concerns, parents, and ad clutter. According to a recent Pew Research poll, youth admitted they don't like the social network as much as they use to. Many bears are concerned that fickle teens might turn Facebook into the next Myspace. 

Zuckerberg addressed those concerns head on in the conference call. Everyone, please go to Facebook's investor relation page and listen to it yourself. It's the best call you'll hear this quarter.

"One specific demographic I want to address is U.S. teens. There has been a lot of speculation reporting that fewer teens are using Facebook. But based on our data, that just isn’t true. [...] But based on the best data we have, we believe that we’re close to fully penetrated in the U.S. teen demographic for a while and the number of teens using Facebook on both a daily and monthly basis has been steady over the past year and half. Teens also remain really highly engaged using Facebook." -- Mark Zuckerberg

Wait, what was that Mark? It's hard to hear you over the cracking sound in my thesis.

So why are teens sticking to the service? It's the network effect. Even with the proliferation of new social networks, Facebook is probably the only place with all of your friends. That's a pretty compelling reason to stay even if you don't like the service 

Jim Edwards at Business Insider had a great analogy to describe this. Facebook is for teens what cable TV companies are for adults: No one likes them but everyone uses them.

It's cheap

My final problem with Facebook was valuation. There has always been concern that Facebook went public too late in its lifecycle. Decelerating growth would result in multiple contraction limiting investor upside. 

But while the stock is trading at a lofty 40 times forward earnings, there're several catalysts that could cause that multiple to grow. Short-term, expect a rush of analyst upgrades as everyone revisits their assumptions. Over the next eight to twelve quarters, Facebook will be running into a series of easy comparables. Expect rapid mobile gains to result in earnings growth acceleration. That spells my favorite two words in the English language: multiple expansion! 

Down goes another premise. 

Foolish bottom line

Facebook has a host of problems. The company faces enormous competition from hundreds of competitors - chiefly Twitter, Google, and Yahoo! - for customer eyeballs and business ad dollars. Attracting the next billion users to the network will be challenging. Investors should still be skeptical of the company's corporate governance with Zuckerburg owning over 50% of shares. All of these issues remain. Regardless, this quarter dismantled the three biggest pillars in my bear thesis. 

It's incredible to think just how much of our digital and technological lives are almost entirely shaped and molded by just a handful of companies. Find out "Who Will Win the War Between the 5 Biggest Tech Stocks?" in The Motley Fool's latest free report, which details the knock-down, drag-out battle being waged by the five kings of tech. Click here to keep reading.

Robert Baillieul has no position in any stocks mentioned. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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