Many investors are worried that Facebook (META 3.25%) is growing too fast. However, the company has yet to monetize its Instagram service. Its more specialized social networks are also growing. Based on the prospects of these developments, let's take a look at whether investors should be apprehensive that Facebook is getting ahead of its fundamentals.
Financials
Facebook relies heavily on two sectors: ad revenues and payments from gaming. Recently, both of these segments have shown progress. On the ad side, Facebook's revenues for the last quarter totaled $1.60 billion, an increase of 61% compared to the same period in 2012. Additionally, Facebook's operating margin has shown dramatic improvements.
While the company expects its 2013 operating margin to hit 31%, Google (GOOGL 1.32%) is hoping for an operating margin of 24%. This does not mean Google is not doing well. The company could increase ad revenues faster than the overall market in the near future. It could adjust its Enhanced Campaigns to shore up its margins going forward. Additionally, it could increase the pace of its monetization of YouTube and encourage the growing adoption of mobile advertising.
Instagram service
Facebook's fortunes could show further improvements when it monetizes the Instagram service. Over the next year, the company plans to add special video advertisements to the platform. This could generate upwards of $1 billion in added revenues for Facebook in 2014, clearing the way for a higher operating margin. The initiative will free up cash for the company to invest in the development of its data center business.
Facebook's peers are also generating ideas to increase ad revenues. Yelp (YELP 2.40%) will continue to partner with companies such as Open Table and Apple to get users spend more time on Yelp. It will also urge customers and businesses to continue adopting its mobile platform and its mobile app. The increase in consumer engagement could enable the company attract more advertising from local businesses.
Social networks
In addition to the great potential in the Instagram service, Facebook could take its earnings to a higher level through partnerships with more specialized social networks. As FourSquare, Tumblr, Snapchat, and others gain popularity, Facebook could flood them with ads. With sustainable expenses and gains from Instagram in the next year, Facebook can sit back and enjoy an even more attractive operating margin.
Just as its rivals are formulating plans for revenue generation, Facebook could initiate strategies to increase revenues from gaming. It is already arranging deals with carriers to enable subscribers use its app and website without payment. The company intends to ramp up Internet users and then grow revenues.
A company like Zynga (ZNGA) is building its entire corporation on the back of gaming. Zynga is pursuing gambling games through partnership with a company called Bwin. The initiative will offer UK players a variety of games with buy-ins at every opportunity. Zynga plans to launch social versions of these real-money games for players on Facebook. If this succeeds, Facebook's margins will improve. Of course, revenues from gaming might seem far lower than ad revenues. However, Facebook needs to see sales soar in an environment of cut-throat competition.
Conclusion
With prospects from the Instagram service and growing popularity of its specialized social networks, Facebook's investors need not be concerned that the company is getting ahead of its fundamentals. Though eyebrows should be raised that its stock price has risen too quickly, it should not cause fear. Facebook has potentials for major profits in the next few years. Investors should take this into consideration when valuing the company.
