Is This Giant Still a Buy?

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

CPCs are declining all across the online advertisement industry as advertisers are increasingly finding it difficult to monetize handheld growth. Yahoo! (NASDAQ: YHOO) and Google (NASDAQ: GOOG) have reported a massive decline in ad pricing. Their advertisement customers are not pleased with the increasing ratio of handheld advertisements, which are less effective as compared to desktop display. Facebook (NASDAQ: FB) has emerged as an exception to the norm with consistent increases in unit advertisements sold and prices charged.

Fundamentals

Last week, Facebook pleasantly surprised the investing community with its second quarter results. The Street was expecting it to post EPS of $0.14 on revenues of $1.62 billion. The company reported EPS of $0.19 on revenues of $1.81 billion, 35% higher than expectations. The results have received an overwhelmingly positive response from investors, and shares are up over 35% since the results came out.

The company saw excellent overall growth in its advertisement revenues, which increased to $1.6 billion for the second quarter. This growth was a result of higher prices charged for advertisements and recent initiatives by the company to match user preferences with advertisements. There was also a significant growth in unit ads sold due to initiatives like ‘News Feed’ advertisements. Facebook is selling, approximately 1 in 20 of all updates on the news feed, to interested advertisers. As long as it keeps the frequency of these advertisements in check, it will continue to drive revenue growth.

Mobile Boom

The superb mobile revenue growth was the biggest surprise from the quarterly results, and it is the primary reason behind the ‘earnings beat’. After a ‘dream IPO,’ the lack of mobile monetization turned out to be a nightmare for investors. Facebook started the pursuit of mobile monetization last year and has already accomplished the impossible. In a matter of mere quarters, it has grown mobile revenues from nothing to 41% of total ad-revenues.

In the recently concluded quarter, the mobile advertisement revenues grew to a staggering $656 million from approximately $11 million in 2Q2012. Mobile revenues were $373 in the last quarter which means a quarter over quarter growth of 76%. This growth in mobile revenues is driven by better monetization and overall ad-revenue growth.

There was a staggering increase of 51% in active mobile users to 819 million. However, the revenue growth is higher than the increase in mobile users which shows that improvements in mobile monetization have been the key for Facebook.

Competitors

The mobile monetization of Facebook has placed the advertisement giant at a considerable advantage to competitors such as Yahoo! and Google. Google is the leading player in the digital advertisement industry but has been facing trouble with mobile monetization. Although the company owns the world’s largest handheld operating system, the Android, it has been unable to leverage this advantage. Instead, it is witnessing a continuous decline in CPCs because advertisers are not enthusiastic about Google mobile advertisements. In the recently concluded quarter, the company missed analysts’ earnings expectations due to this unprecedented decline in CPCs. The popularity of ‘smartphone apps’ can be a long term worry for the company because they reduce the need for Google search.

The display advertisement giant, Yahoo!, is also facing similar troubles. Unlike Facebook, the company has witnessed a steady decline in advertisement prices. During the second quarter, Yahoo!’s advertisement prices declined 12% year over year. Last quarter there was a 2% year over year decline in price per ad. The company has a significant presence in mobile with almost 340 million users but generates only $125 million in mobile revenues. Yahoo!’s valuations are now tied to the highly anticipated IPO of Alibaba. The trading website is being valued as high as $120 billion by the sell side.

Valuations

Facebook is currently trading at its 52-week high and pretty close to its IPO price of $38. The Street expects Facebook to post EPS of $0.71 in 2103 and $0.94 for 2014. However, the recent improvements in mobile monetization, ad-prices, and advertiser interest demand higher expectations. The company is trading at a forward P/E of 37x, much higher than the industry average of 27x.

The current estimates do not account for the new optimistic expectations from revenue and profit growth. Therefore, if we use high-end 2014 EPS estimates ($1.16) and a P/E multiple of 37x, a target price of $43 can be calculated. This is a 15% upside to the current price level. This also shows us that chances are slim that Facebook will shoot up in the short term as the stock is trading pretty close to its 2014 target price.

Bottom line

Facebook has surprised investors and the analysts by posting massive growth in mobile advertisements. The review of Google and Yahoo! results shows that this is a not an industry trend but the rewards of superior mobile monetization by the company. The news feed advertisements are becoming increasingly popular with advertisers, but Facebook will have to control their volume to ensure users do not get irritated.

The massive improvements in mobile monetization call for estimate revisions and higher target prices. However, the company is already trading at a pretty high forward earnings multiple and is near the mean sell side target price. Therefore, short-term investors should not expect immediate gains. Long-term investors can target this growth story with a 2014 target price of $43. 

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Mohsin Saeed has no position in any stocks mentioned. The Motley Fool recommends Facebook, Google, and Yahoo!. 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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