February 2, 2012 8:34 pm

Investors seek things to like on Facebook

A solid online advertising business – though not quite the juggernaut that some had hoped - and with key questions still hanging over the value of “social” and mobile advertising to the world’s big consumer brands.

That has been the verdict from analysts and investors in the wake of Facebook’s IPO filing. The paperwork, which gave the first in-depth look at the company’s finances, has paved the way for a debut on Wall Street expected in May.

Facebook graphic

Facebook graphic

More

On this story

On this topic

IN Technology

The filing also revealed a business that, though highly profitable, faces sharply rising costs from expanding its workforce and building a network of datacentres, as it races to consolidate its lead and become the world’s dominant social networking platform.

For anyone hoping that the new forms of social advertising pioneered by Facebook would produce the sort of stellar early results once seen from Google’s search advertising, the filing is a reality check.

With $3.2bn in advertising last year, Facebook has quickly emerged as one of the dominant online businesses, though the numbers were below what many had anticipated.

Also, while up 69 per cent from a year before, advertising growth slowed sharply from the growth of 145 per cent the year before. For a company whose shares will trade on expectations of continued sky-high growth, any further signs of deceleration will be scrutinised closely in coming quarters.

The answer will rest heavily on whether Facebook succeeds in tying advertising to the highly effective social mechanisms that keep users coming back to its site to “share” information with people in their networks.

Up to now, it makes relatively little money this way. Starting in late 2010, the company began flooding its users’ pages with low-value “display” advertising, cramming six or even seven messages into the right hand columns at one point. Though probably accounting for 60 per cent of its overall advertising revenue, this has resulted in “drecky” messages that its users have found irrelevant, says Debra Williamson, principal analyst at eMarketer.

Facebook changed course in late 2011, its filing shows, introducing higher minimum bids on the auctions that underpin this form of advertising in an effort to raise quality – and prices. The move reflects steps Google has taken in the past.

The question is whether Facebook can succeed in adding a stronger social dimension to the way users interact with newer forms of advertising. An 18 per cent increase in the average prices of its adverts last year was one early sign that big consumer brands are starting to respond. However, Ms Williamson said Facebook had yet to persuade many brand-owners, which get free promotion from users visiting their pages that they should also pay for advertising.

Meanwhile, the company’s filing left another big question: around half of its 845m users access Facebook on mobile devices, a number that is expected to increase, yet it still carries no mobile advertising. That could eventually eat into its business as more users switch to mobile, and is one of the “risk factors” listed in the filing. It has added to expectations that Facebook will soon announce a new mobile advertising platform, perhaps even before its IPO.

With the advertising business yet to turn into the sort of goldmine seen in Google’s early days, attention has shifted to other ways it could make money.

“To get comfortable with the valuations people are talking about, you have to be assuming they will develop other revenue streams,” said Ryan Jacob, a US internet fund manager.

So far, Facebook has levied a tax on the games played on its site, taking 30 per cent cut of the money users spend. That has already grown to 15 per cent of its revenues, with Zynga alone supplying 12 per cent – a sign of the great potential from levying these sorts of transaction fees.

Facebook’s profit margin slipped slightly last year as it ramped up spending – a reverse of the “operating leverage” normally seen when young companies with high fixed costs see a sharp increase in revenues. Employee numbers jumped 50 per cent last year, to 3,200 and it opened its first company-owned datacentre.

“It’s a modest surprise that there isn’t more leverage,” said Mr Jacob. “They’ve been investing aggressively.”

Despite that Facebook still has profit margins that would be the envy of most young businesses, particularly ones in the early stages of rapid growth that require massive investments. Its operating profit margin last year, of 47 per cent, was still roughly equivalent to the 50 per cent that Google reported in 2005, when its net revenues were at a similar level.

Related Topics

Copyright The Financial Times Limited 2014. You may share using our article tools.
Please don't cut articles from FT.com and redistribute by email or post to the web.

NEWS BY EMAIL

Sign up for email briefings to stay up to date on topics you are interested in

SHARE THIS QUOTE