Facebook’s (NASDAQ:FB) stock jumped more than 30% after the company reported its Q2 2013 financial results. Mobile advertising revenues showed strong growth driven by an increase in the number of marketers, growing advertising demand and the strong performance of news feed ads. Facebook’s monetization strategy has been the primary concern of investors and the second quarter results dispelled some of that. The company’s overall advertising revenues swelled 61% over Q2 2012, amounting to $1.6 billion primarily due to the ramp up of advertising on mobile platform. 
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Facebook’s other businesses such as social commerce and virtual goods sales witnessed much slower growth. The company believes that it has a tremendous opportunity to grow its advertising business over the course of next few years as mobile advertising currently accounts for only 2% of global advertising sales (not specific to Facebook), and this percentage is likely to grow.  In addition to this, marketers are increasingly recognizing high ROI (return on investment) that they can get by promoting their products on Facebook. Due to strong second quarter results and substantial improvement in monetization, we have raised our price estimate for Facebook to $30.
Margins are under pressure as the company is hiring aggressively to support the development of a host of features including gifts, graph search, custom audience and app-install ads. It has stated that its non-GAAP operating expenses will grow by 50% in 2013, and will outpace the revenue growth as it continues to invest in enhancing site features, ad effectiveness and potentially rolling out new products. 
Facebook Focusing On Mobile Growth
There is no doubt that mobile remains Facebook’s focus, and the company is aggressively trying to grow the number of active users on this platform as well as add to the number of ads within its feeds. In the second quarter, monthly active users on mobile reached 819 million, implying growth of 50% over the same period a year ago.  This also means that 70% of Facebook’s overall monthly active users are also accessing the network through their smartphones. Mobile advertising revenues represented about 41% of the company’s overall advertising revenue for the second quarter, up from 30% in Q1 2013.  That’s a huge sequential jump and surprised the investment and analyst community.
The number of ads within Facebook’s mobile feeds have increased significantly over the last few quarters and their improving effectiveness is driving ad pricing higher. The company stated that its overall ad impressions grew by 43% compared to the second quarter of 2012, with average price per ad jumping by 13%.  The fact that overall monthly active users grew by 20% as compared to 43% growth in the ad impressions points to two possible implications. First, Facebook has managed to increase the ad density on its website without significantly impacting the user experience. Second, users are browsing through more Facebook pages now which indicates higher user engagement. Whatever the case may be, the outlook for the company is encouraging.
More Advertisers Are Opting For Facebook
Facebook stated that direct response marketers increased their advertising spend significantly because of high click-through rates that they are seeing on the social network. These advertisers are measurement-focused, and it appears that Facebook’s targeted ads are delivering attractive ROI (return on investment) for them. In addition to this, local business continued to flock to Facebook due to its targeted approach, and the company surpassed 1 million active advertisers this quarter, doubling its count from a year ago. 
The company mentioned that an analysis by Datalogix of 55 ad campaigns on Facebook over the past six months suggests that advertisers’ median ROI was much higher when their campaign included feed based ads.  Mobile is becoming an integral part of these campaigns. For instance, the company launched a huge mobile advertising campaign for Wal-Mart (NYSE:WMT) during the holiday season and around 50 million ads focusing on deals and discounts were rolled out to millions of Facebook users.
Facebook’s efforts to make its ads more engaging is driving the higher ROI. The company is also leveraging a vast amount of user data to help advertisers reach the right audience. Certain measures suggest that the effectiveness of advertisements on Facebook’s social networking platform are growing and that bodes well for the company’s future.
A Facebook study shows that Bud Light’s ads, which were posted on its Facebook page, were highly effective. These ads reached 20% of U.S. households and improved sales by 3.3%, thus offering a six times return on the ad spend.  Another study showed that when measured holistically, the cost per acquisition on Facebook is 68% less than the cost on other online channels.  The company’s ‘custom audience’ product, which basically combines its user data and advertisers’ customer data to increase the effectiveness of the ads with improved targeting, is seeing good traction.
Our price estimate for Facebook stands at $30, implying a discount of about 10% to the market price.Notes: