What Facebook Bears Aren't Telling You

Now that Facebook's (NASDAQ: FB  ) reached a new all-time high, some investors are concerned that the Facebook narrative is getting ahead of its fundamentals. These wary investors will use statistics to show you that the company's stock price has risen too quickly, and the market's enthusiasm is misplaced. But digging into the numbers these bears are throwing out there suggests they're the ones getting ahead of themselves.

Margin
Facebook's non-GAAP operating margin fell from 53% in the second quarter of 2011 to 44% in the second quarter of 2013.

The biggest culprit is the mass migration of desktop users to mobile devices. In the last two years, mobile monthly active users climbed from 325 million to 819 million increasing from 44% of total users to 71%. In just the last year, the number of users accessing Facebook on their mobile devices has doubled. Meanwhile, the percentage of ad revenue coming from mobile devices remains low comparatively, representing just 41% of total ad revenue.

This means mobile users are harder to monetize.

Yet in the past year, Facebook has increased its revenue from mobile users from essentially $0 to $650 million last quarter. Analysts at J.P.Morgan expect mobile revenue to double from 2013 to 2014, making up 60% of total ad revenue. The trend implies mobile monetization is approaching parity with desktop, which ought to put a damper on any margin pressure the company is experiencing from an increase in mobile users.

Furthermore, Facebook has more than 150 million active users sharing photos on Instagram that it has yet to monetize. Currently, the $1 billion-plus the company has poured into the platform has yet to return a penny in revenue, but Facebook expects to start selling ads on Instagram within the next year.

Overall, we ought to see revenue grow faster than costs in the next year. Yes, operating margin decreased significantly in the last two years, but that trend looks should reverse itself.

Losing users
Another concern from investors is that Facebook is losing users in the U.S. and Western Europe. As more specialized social networks; including Instagram, FourSquare, Tumblr, Snapchat, and a slew of others become popular and Facebook alienates some users by flooding them with ads, many people are spending less time on Facebook. At least, that's the theory.

In fact, Facebook continues to increase users in North America and Europe every quarter. While growth is slowing, that's to be expected when the company has already captured practically the entire adult (15-65) populations of the U.S. and Canada.

So even if Facebook isn't exactly losing users, the fact that it's nearing complete saturation in its most profitable markets ought to be a big cause for concern, right? Well, Facebook is seeing significant revenue growth in the saturated regions as ad revenue per user increased 42% in the U.S. and Canada and 38% in Europe quarter over quarter. More interestingly, ad revenue per user is increasing even faster in its less saturated markets with average ad revenue per user increasing 45% in Asia and 50% in the rest of the world.

Bears will cite the increased competition from Asian social networks. For example, Sina  (NASDAQ: SINA  ) Weibo sports well over 500 million users. It's certainly the social network of choice in China, but its user base of 500 million is actually closer to 50 million as the site is rampant with fake accounts used to artificially increase users' social status. That's closer to 4% penetration of the country's population, which means Sina doesn't have that big of a lead over Facebook, which doesn't have as much of a presence due to government censorship.

Indeed, the number of ads on Facebook has grown, which may have caused some users to abandon the site. Yet the total number of users continues to grow in every region, and the benefit of more ads clearly outweighs the few users who left.

Online advertising concerns
Facebook is an advertiser just like Google (NASDAQ: GOOGL  ) or Yahoo!. The industry as a whole is facing headwinds, and that's cause for concern. Average ad prices for Google fell 4% in the first quarter of the year and 6% last quarter.

Google introduced "Enhanced Campaigns" earlier this year in an attempt to mitigate the impact of lower-priced mobile search ads. The new ad program requires brands to purchase mobile ads. If the company's second-quarter results are any indication, Google may need to reconsider how it serves ads on mobile instead of simply requiring advertisers to buy the lower-conversion product.

The story at Facebook is a little different.

As Facebook increases the number of brands bidding on ads and its ad efficacy, it ought to be able to increase ad rates faster than Google. In fact, William Blair analysts recently issued a report detailing that Facebook advertisers would be willing to pay three times the amount for the ads they bought. The same report estimates ad rates could increase 25% next year.

Facebook is leading the way in mobile ad innovation. That's sure to attract large numbers of advertisers which will drive ad prices. In the last year, Facebook more than doubled the number of active advertisers on Facebook Exchange. As a result, ad prices were up 13% year over year. 

Moreover, Facebook is attracting valuable local advertisers as Mark Zuckerberg pointed out on the company's most-recent conference call. These ads are priced significantly higher than national ads and are another bullish sign for average ad prices at the company.

While advertisers like Google are struggling to grow ad rates, Facebook has bucked the trend. I expect Facebook to continue growing ad rates, as it has only penetrated 5.5% of businesses with a presence on the site.

Numbers actually support the narrative
The story at Facebook is that the company is running on all cylinders, and as much as Facebook bears might use numbers to back up their fears that the stock has run up too much, a closer look shows the numbers actually support the narrative. Facebook is growing its users, its average revenue per user, its ad rates, and the number of advertisers on its exchange. All signs point to better operating margin going forward, and the company has several catalysts -- Instagram, video ads, potential ad network -- to drive the stock higher.

It always pays to dig deeper on numbers.

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