Facebook (NASDAQ:FB) raised the bar last quarter with a surprising jump in its advertising revenues, and it will be interesting to see whether the company can sustain the growth when it releases its Q3 2013 results on October 30th. Facebook’s Q2 2013 advertising revenues swelled 61% over the second quarter of 2012, amounting to $1.6 billion, primarily due to the ramp up of advertising on its mobile platform. Given that most of the users access the site through mobile devices, once again the mobile business will be in focus. Facebook is benefiting from an increasing number of marketers, growing advertising demand and the strong performance of news feed ads.
The company’s other businesses such as social commerce and virtual goods sales still remain small and will not materially impact the results. The big picture is that a large portion of Facebook’s valuation is tied to its advertising business, and the company will need to demonstrate its ability to sustain the growth in this industry to justify its market valuation. Facebook’s current stock price suggests lofty expectations from the market. Our price estimate for Facebook stands at $30, implying a discount of about 40% to the market price. There are certainly some reasons to be optimistic about the stock, but there are risks to be considered too (read Key Risks For Facebook As Stock Continues To Climb).
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Mobile Advertising Growth Will Continue To Be In Focus
More than 70% of Facebook’s overall monthly active users are also accessing the network through their smartphones, which implies that optimizing ads on the mobile platform will continue to be a priority for the company. Mobile advertising revenues represented about 41% of Facebook’s overall advertising revenue for the second quarter, up from 30% in Q1 2013.  That was a huge sequential jump and surprised the investment and analyst community leading to a strong run up in the stock. While we don’t expect the third quarter to do better sequentially, the year-over-year growth will remain strong as Facebook continues to introduce new features to optimize its platform for ad targeting.
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. In Q2 2013, Facebook’s 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 are growing at a slower rate than 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.
The graph search feature has gained popularity among the users and could well define the company’s future as a premier search platform, making it even more attractive to advertisers.
Global Rise In Digital Ad Spending Will Work In Facebook’s Favor
Global digital ad spending stood at $102.8 billion in 2012, up from $72.4 billion in 2010.  More marketers are opting for digital ads as online advertising is cheaper and more targeted, thus offering better returns on investment. The total spending through this channel is expected to top $163 billion in the next few years. While North America will continue to account for the majority of this market, Asia and Africa will emerge as new growth avenues.
Facebook will continue to be at the forefront of this growth. The company has increased its share of the global digital advertising market from 2.6% in 2010 to 4.2% in 2012. By 2016, we expect this figure to reach almost 8% as Facebook continues to experiment with new ad formats such as video ads, increases user engagement, gains higher leverage in negotiations due to its highly targeted approach, and expands internationally. However, our price estimate can jump by 50% if this share was to increase to 12%, implying annual ad revenues of $20 billion.
Our price estimate for Facebook stands at $30, implying a discount of about 40% to the market price.Notes: