Key Risks For Facebook As Stock Continues To Climb

by Trefis Team
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Facebook (NASDAQ:FB) has significantly improved its advertising business over the last few quarters, especially on its mobile platform. The company’s stock has surged roughly 60% following its Q2 2013 earnings announcement that reflected strong ad revenue growth. The business is getting support from a growing number of marketers, rising advertising demand and the success of news feed ads. The positive market sentiment is understandable, but let’s not forget the risks that the company faces.

It is true that Facebook has made big strides in its business in the last three quarters, but the question is – how long can it sustain this growth? The stock could slide if the ramp in mobile advertising begins to taper and the company hits its monetization cap. Such a cap will be determined by a delicate balance between ad density and user experience. In addition, Zynga’s lower contribution, competition from Google+ and the possibility of social networking fatigue creeping in are very real risks.

See our complete analysis for Facebook

Risk: Monetization Growth Halts

Facebook’s users are increasingly accessing the social network on mobile devices where there is not much real estate to put ads. Also, 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. Despite this, the company has done well so far in terms of increasing the efficacy and number of ads on mobile.

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. Mobile advertising revenues represented about 41% of the company’s overall advertising revenue for the second quarter, up from 30% in Q1 2013. [1] The company stated that its overall ad impressions grew by 43% compared to the second quarter of 2012, with the average price per ad jumping by 13%. The fact that overall monthly active users grew by 20% as compared to 43% growth in 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. Secondly, users are browsing through more Facebook pages now which indicates higher user engagement.

Although the company is heading into the second half of 2013 with guns blazing, it is important to ask the question – how long will it take before the growth slows down meaningfully? According to our estimates, the current market price implies acceleration in Facebook’s monetization growth (revenue per 1000 page views). We believe that such acceleration may not be sustainable and the growth is likely to come down in the next couple of years. Facebook simply cannot keep on increasing ads without risking user backlash or losing them to other social platforms.

Risk: User Engagement Suffers

Facebook’s monthly page views per user have shown a substantial jump in the last few years, but higher competition and social networking fatigue can impact 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 happening because online social media continues to see a boom, leading to users being overloaded with information. While we believe this to be a minor deterrent considering Facebook’s ubiquity and popularity, it can still impact the overall user engagement.

Competition from other websites such as 9GAG, Reddit, Quora, and Twitter also exists. They don’t necessarily need to compete with Facebook on its own turf, but as long as they eat into the share of user time, they pose a risk to Facebook’s engagement metrics such as number of page views per user. This will directly impact the company’s ad revenue growth.

Risk: Google+ Draws In Audience By Partnering With Zynga

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 $30, implying a discount of roughly 30% to the market price.

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  1. Facebook’s Q2 2013 Earnings Transcript []
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