Why Facebook Is Even Scarier Than You Realize

NEW YORK (TheStreet) -- On the surface, Facebook's (FB) second-quarter earnings report was scary-good enough. But the details under the hood held even more ammo for investors who want to bet that Federal Reserve Chair Janet Yellen is wrong about social networking stocks.

The numbers knocked the snot out of Wall Street's expectations. Revenue of $2.91 billion was $100 million more than forecast, and earnings per share of 42 cents beat forecasts by a dime. The really impressive part, though, was the breadth in the number and platforms and types of advertising Facebook is now beginning to move.

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Investors have already focused on Facebook's expansion into mobile advertising sales, which rose 151% in the quarter and are now more than three-fifths of Facebook's revenue. The piece emerging now is Facebook's promising tests in areas like video advertising, and the surprising strength of mobile as a platform for brand advertising that drives longer-term purchasing plans as well as impulse buying. As those  happen, the company's long-term goal to boost annual revenue toward $20 for each of its users gets closer, and easier to focus upon.

Facebook's magic number has long been $20 per user -- the figure one of its early investors privately quoted to a bunch of reporters over dinner the night the company filed for its 2012 initial public offering. Back then, it was commanding a little above $4, and the second-quarter report puts sales per user at $8.96 now (up from $8 in the first quarter). It's a rough guide to how close Facebook is at any one time to what it will be when it grows up.

That metric points to plenty of growth still to come -- and the proliferation of platforms is the primary reason why it now looks easily achievable.

The company spent part of its conference call talking up its experiments in video advertising, which Facebook Chief Operating Officer Sheryl Sandberg said has involved about a dozen advertisers to date.

The fascinating part of video is that if it works, it greatly expands the type of advertisers Facebook can serve and adds a huge new dimension to its business model. Most online-media companies, led by Google (GOOGL) and Facebook, specialize in ads that are narrowly targeted using lots of customer data. Especially for search engines like Yahoo! (YHOO) and Microsoft's (MSFT) Bing, the idea has long been that people used search and other online media when they were researching purchases they planned to make fairly soon.

Old media, especially TV, were thought to be the redoubt of brand advertisers, who want to plant favorable impressions of General Motors (GM) cars or Procter & Gamble's (PG) detergents to consumers who would buy later. Walt Disney's (DIS) ESPN.com has been one of the Web's big successes because of its ability to get consumers to sit still for online video ads (easier for them because Web surfers think of ESPN as a TV network first) has let them put much more video on its site than most publishers.

For Facebook, the push to video reinforces a surprising new finding about mobile advertising -- that it's a better branding platform than early pundits expected. Back in 2009 or 2010, the expectation was that mobile ads would flow to location-based services like Foursquare. The idea was what was known as the Pork Chop Theory: If your phone knew you were near a butcher shop, it would show you ads or coupons for pork chops to get you to walk in.

Now, academics think that mobile is much more useful than they realized for selling items like washing machines. Researchers at Columbia Business School who studied mobile ads' impact on 50 different products says even simple ads with little information -- because phone screens are so small -- are effective at forcing consumers to keep thinking about cars, for example, they may have been considering for weeks or even months. Mobile "seals the deal,'' said Miklos Sarvary, co-director of the Media Program at Columbia Business School and co-author of the study released last week.

For Facebook, new ad platforms like video (and Instagram, where advertising is still getting off the ground) and new discoveries about the kind of sales the company can help clients make are just mo' money. They put $20 per user within much more tangible reach. And collectively, they make clearer and clearer why, if there's a social networking bubble, Facebook isn't a part of it.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates FACEBOOK INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:

"We rate FACEBOOK INC (FB) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its robust revenue growth, largely solid financial position with reasonable debt levels by most measures and impressive record of earnings per share growth. However, as a counter to these strengths, we find that the stock itself is trading at a premium valuation."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • FB's very impressive revenue growth greatly exceeded the industry average of 12.1%. Since the same quarter one year prior, revenues leaped by 71.6%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • Although FB's debt-to-equity ratio of 0.02 is very low, it is currently higher than that of the industry average. Along with this, the company maintains a quick ratio of 13.15, which clearly demonstrates the ability to cover short-term cash needs.
  • Powered by its strong earnings growth of 177.77% and other important driving factors, this stock has surged by 149.19% over the past year, outperforming the rise in the S&P 500 Index during the same period. Setting our sights on the months ahead, however, we feel that the stock's sharp appreciation over the last year has driven it to a price level which is now relatively expensive compared to the rest of its industry. The implication is that its reduced upside potential is not good enough to warrant further investment at this time.
  • The company's current return on equity greatly increased when compared to its ROE from the same quarter one year prior. This is a signal of significant strength within the corporation. When compared to other companies in the Internet Software & Services industry and the overall market, FACEBOOK INC's return on equity is below that of both the industry average and the S&P 500.

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