Has Facebook Crossed The Mobile Threshold?

By Stephen D. Simpson, CFA | July 26, 2013 AAA

There never seems to be a middle ground on Facebook (NYSE:FB), as opinions run very hot or cold based on the latest data point (real or imagined) concerning the company. There's no question that Facebook surprised the Street with its mobile ad revenue growth this quarter, and user data seems to run counter to the worries that users are disengaging from Facebook. While I remain basically bullish on the company (and the stock), that comes with the warning that sell-side analysts are significantly jacking up their estimates in the wake of this quarter and any shortfall in the third quarter will be swiftly and brutally punished.

Ad Revenue Breaks Out
Facebook not only beat estimates for the second quarter, it pretty much stomped them. Revenue rose 53% from last year and 24% from the prior quarter, beating the average expectation by more than 10%. Although payments revenue was soft (up 11% and flat, respectively), ad revenue jumped 61% and 28% on a 76% sequential improvement in mobile revenue. Unlike Google (Nasdaq:GOOG) and Yahoo! (Nasdaq:YHOO), Facebook saw significant ad price growth, with pricing up 13% overall and up 40% in North America.

Sell-side analysts have pretty much gone giddy with the revenue and user data from Facebook's second quarter, but the profit development wasn't bad either. Gross margin was up more than five points, while non-GAAP operating income rose 54%, though operating margin improved only modestly.

SEE: 4 Companies Behind The Social Media Curtain

Keeping Users, And Monetizing Them, Seems To Be Going Well
One of the continuous points of concern about Facebook is the level of user engagement and satisfaction. Plenty has been written about how younger users are not as interested in Facebook and that rival social media platforms like Twitter and Google+ are gaining as a result. In spite of that, Facebook's active user count continues to grow (up 21% and 4%), and the ratio of daily users to monthly users improved to 61%. At the same time, average revenue per user improved 26% and 19%, so it seems as though Facebook is not having as much trouble as feared in keeping and monetizing its users.

Given the sheer size of Facebook, I'm not sure how much or how quickly the platform can grow at this point. Even so, opportunities like video ads (coming this summer) and adding video to Instagram should keep the revenue rolling in. What's more, the Graph Search concept is still pretty young and could yet prove to be a valuable additional platform for ads.

At the same time, it seems like the company has done a good job of fencing in the risk from the Zynga (Nasdaq:ZNGA) relationship. Elsewhere, companies like LinkedIn (Nasdaq: LNKD) and Angie's List (Nasdaq: ANGI) seem to be trying to run pages from Facebook's playbook, but not to the same effect so far.

SEE: The Power Of Social Media: Influencing Trading And The Markets

The Bottom Line
Facebook is going to get plenty of well-deserved praise for the big leap forward the company made this quarter with its mobile ad revenue efforts. At the risk of sounding like a curmudgeon, I'm a little concerned that analysts are going overboard with adjusting their models and taking this result as the “new normal”. It's not that I don't believe Facebook can get there, rather it's just that I won't be surprised if there is some volatility/inconsistency at some point in the next few quarters, and I expect that the shares will react sharply to it.

Barring a sharp reversal in the progress seen this quarter, I think Facebook shares are likely to still be undervalued even after the big expected pop today. With fair value in the mid-to-high $30s, there's still room for the shares to go, though the volatility here may make this a tough stock for some investors to hold.

Disclosure: At the time of writing, the author did not own shares of any company mentioned in this article.

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