What Are The Downside Risks For Facebook?

by Trefis Team
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Although Facebook (NASDAQ:FB) has shown improved growth in recent quarters, there are still risks that investors should watch. Despite stronger revenue growth, the stock could not sustain the momentum it gained from November to January. The margins are shrinking and there is still doubt as to whether Facebook will be able to substantially improve its monetization over the long term.

In our previous analysis, we looked at certain factors that could propel Facebook’s stock (see How Could Facebook Hit $40?). In this note, we’ll focus on the risks that the company faces including the possibility of not being able to monetize the mobile platform to adequate levels, reduced contribution from Zynga, competition from Google+ and the possibility of social networking fatigue creeping in.

See our complete analysis for Facebook


Monetization May Remain Weak

Facebook’s users are increasingly accessing the social network on mobile devices where there is not much real estate space to put ads. Additionally, Facebook does not serve audio ads like Pandora, and thus, is completely reliant on visual ads. Even though the problem is straightforward, the solution is not. Any attempt to significantly increase ads on a mobile platform can affect the user experience negatively due to the limited real estate on mobile screens.

To address this issue, Facebook has been ramping up its mobile ad efforts for the last few quarters. The number of ads within Facebook’s mobile feeds have increased significantly and their effectiveness is also driving its ad pricing up. The company launched a huge mobile advertising campaign for Wal-Mart (NYSE:WMT) during the holiday season. About 50 million ads on deals and discounts were rolled out to millions of Facebook users. Although the results were mixed, this marks an important step towards strengthening the monetization of Facebook’s mobile platform. While there was a high level of user engagement, there were also complaints about unwanted ads. The company is also working on promoting ‘custom audience’, which basically combines Facebook’s user data and advertiser’s customer data to increase the effectiveness of target ads. It is also focusing on app install ads, which were launched in October 2012 and are being used by one-fifth of the top 100 grossing iOS apps to accelerate growth.

However, there is still a chance that Facebook’s efforts to effectively monetize the mobile platform may fail, and growth in international markets further puts downward pressure on the monetization levels. If these factors actually push down the monetization to 20 cents per 1,000 page views by the end of our forecast period, there could be a massive 40% downside to our price estimate for Facebook.

Number Of Page Views May Get Affected

Facebook’s monthly page views per user have shown substantial jump in the last few years, but higher competition and social networking fatigue can impact their growth in the future.

As of April 2013, Google’s (NASDAQ:GOOG) homegrown social network Google+ had close to 359 million active users and over 500 million registered users. In terms of scale, Google+ remains the biggest threat to Facebook in the social networking space. Competition from the network is likely to increase further given Google’s aggressive promotion as well as the seamless integration it can achieve with its other services such as YouTube. According to an August 2011 report by Gartner, a survey conducted on around 6,000 social network users revealed that 24% of the respondents were using their social sites less often than when they signed up. This may be coming about because online social media continues to see a boom, leading to users being flooded with an information overload. While we believe this to be a minor deterrent considering Facebook’s ubiquity and popularity, it can still impact the overall user engagement.

Strained Ties Between Zynga And Facebook

Zynga is now subject to Facebook’s standard policies and procedures as far as the use of Facebook’s platform and data is concerned, implying that any favoritism that might have existed is now gone. While this is certainly not a good development for Zynga, Facebook can also face the negative impact if Zynga’s own gaming platform gains popularity.

In 2011, approximately 12% of Facebook’s revenues came from Zynga. However, this proportion has been decreasing as Facebook is growing its other revenue channels and promoting numerous game developers. Additionally, some of Zynga’s games haven’t performed as well as its initial games that went viral on Facebook. In Q3 2012, Facebook’s revenues from Zynga decreased by 20% compared to the same period in 2011. However, revenues from Facebook’s remaining gaming ecosystem grew by 40%.

While this implies that Facebook is currently doing fine without Zynga, that may not necessarily be true in the future, assuming that Zynga regains its popularity with focus on mid-core games and real-money gaming. What if Google+ promotes Zynga too just the way Facebook did in its early stages? That could give the rival social network some competitive advantage.

Our price estimate for Facebook stands at $23.30, roughly in line with the market price.

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