What Does the Facebook Growth Story Look Like?

Apparently, Facebook (NASDAQ:FB) did not get invited to the market rally party on Friday. Shares were off as much as 3 percent while the markets soared around it and Google (NASDAQ:GOOG) hit a fresh all-time high. Analysts and investors are apparently punishing the stock for its fourth-quarter and full-year 2012 results, which were released on Wednesday after the markets closed.

Ostensibly, the results were good. In fact, 40.1 percent revenue growth to $1.58 billion beat estimates for $1.53 billion, and earnings growth of 13.3 percent to $0.17 per share beat estimates for $0.15. Monthly active users climbed 25 percent year over year and daily active users were up 28 percent. Perhaps most importantly, mobile revenue increased 9 points to 23 percent of total ad revenue, a tremendous step in the right direction.

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But behind the strong numbers were bad news bears, grumbling about shrinking margins, climbing costs, and a fuzzy monetization strategy.

Facebook, Inc. Stock Chart - FB Interactive Chart - Yahoo! Finance

Facebook QuestionOne of the first negative signs was a drop in fourth-quarter margins from 48 to 33 percent. Operating costs climbed 67 percent, faster than revenue, to $849 million. Taken by itself, this is not necessarily a bad thing. Investment cycles are critical for tech companies, and Facebook’s future profitability will in many ways be a function of its current R&D spending. After all, innovation will allow the company to further monetize its growing mobile user base, now 680 million strong, nearly 68 percent of its entire user base.

What’s more, mobile-only MAUs grew 89.2 percent year over year to 157 million, or nearly 16 percent of total users. Mobile-only MAUs grew at a faster rate than total MAUs (25 percent year-over-year growth), and faster than mobile active users in general (39.4 percent year-over-year growth).

If this is at all indicative of a usage trend, then Facebook is looking at a future where, in the absence of effective innovation, revenues will decline. Just to reiterate the point, mobile ad revenue accounted for just 23 percent of total ad revenue, which is not at all proportional to mobile use volume. As it stands, Facebook earns far less money per mobile user than per desktop user.

Facebook PhoneTo tackle this, Facebook has deployed the “it takes money to make money” model. Consensus is that mobile is the future, and Facebook is mobile, but the business model hasn’t been totally fleshed out yet. There are advertising dollars to be earned, but the mechanisms, services, and products aren’t mature enough yet.

CEO Mark Zuckerberg explained in the conference call: “We’re coming out of a year with a strong foundation and lot of momentum. Just last week, comScore put out a report saying that Facebook now accounts for 23 percent of all time spent on apps in the U.S. And one of the next biggest apps is Instagram at 3 percent. So put together we’re now more than a quarter of the time spent in apps. Today there’s no argument. Facebook is a mobile company.”

It is important not to overlook the fact that at the beginning of 2012, Facebook had zero mobile ads. Facebook has performed an incredible feat of monetization that is overshadowed by its still-negative returns. No, Facebook would not be able to both reduce costs and raise revenue as a mobile-focused company right now, but it will in the future.

The proof that it will be able to do this is its historic growth, which is both competent and relentless despite the fact that the company is navigating uncharted territory. Facebook’s leadership is confident that the current investment cycle, while undefined, will yield more robust revenue streams and high profits down the road.

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