Facebook: A Closer Look

NEW YORK (TheStreet) -- Facebook (FB) reported its third-quarter financial results Wednesday afternoon after the market closed. By first accounts, the business looked good. According to a research note, Canaccord Genuity analyst Michael Graham increased his target price to $62 from $60 and reiterated his buy rating. He also increased his 2013 and 2014 EPS and revenue estimates.

While everything looks great according to the numbers, Graham cautioned that margins may be affected as the social network will need to spend more R&D money to efficiently monetize its strongest growing segment, mobile advertising.

But this rosy outlook certainly did not reflect the mood of traders. The initial knee-jerk reaction to the numbers was extremely positive, and the stock price shot up beyond the implied move. But, as the conference call wore on, there were a few gotchas, in particular the apparent flight of teenage users from the ubiquitous social platform. After that, the stock price plummeted, as much as 1% lower at the close.

The morning after, Facebook's price dropped even further, and whipsawed about, along with the broader market until it finally gained some footing and closed up $1.20 for the day, or 2.44%. The stock was up 1.88% to $51.19 shortly after market open on Friday.

The comment about teenagers was a huge surprise, as investors know advertisers see this as a huge opportunity lost before it can even be realized. I also suspect that traders were still a bit tattered by the Fed hinting at a premature end to QE3 just a couple hours prior to the earnings call.

It is becoming clear that many investors are still not entirely convinced that this growth in advertising can be sustained. There's the lingering concern that some other disruptive technology or competitor may appear on the horizon, and bite into Facebook's fragile and perhaps de minimis revenue model.

In the early days of the company, when subscriber growth was increasing at exponential rates, kids were the primary users, despite the age restrictions for user accounts. The kids grew older, and slowly adults became more interested in Facebook. There are plenty of people out there eager to see what others are up to and also devote long hours to updating their statuses.

Later, Facebook added an applications API that encouraged more wasting of time, and as a side effect attracted multi-level marketing types, who saw this as an opportunity to game the system and attract tens of thousands of followers so they could hawk their courses, most of which were on how to become a multi-level marketer. Facebook squashed that movement by limiting accounts to 5,000 so-called friends.

Facebook was still without a revenue model, so it introduced ads, but nobody could figure out how to make them profitable. The ads were too darn expensive for the individual, and quite frankly, most people ignored them. Then Facebook added beef to its demographics engine and convinced big corporations they needed a presence there...which wasn't a hard sell, as 1/9th of the world's population was on Facebook.

So now, it's all about keeping people engaged in the platform. If they leave for somewhere else, there would be no reason for advertisers to stay. This is why investors were spooked by the thought of kids abandoning their Facebook for some other shiny new disruptive site like Tumblr or Snapchat.

I suppose Facebook could acquire all these technologies, but sooner or later, something bigger and better will come along, and Facebook will become the next MySpace.

-- Written by Ernie Varitimos, Lead Trader AppleInvestor.

At the time of publication, Varitimos had no positions in stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Ernie Varitimos has a long history with Apple as an investor, trader and consumer of its technology. He started his career as a rocket scientist and has spent the past 25 years driving, controlling and influencing technology in the financial industry. Ernie is a former hedge fund manager and current futures trader.

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