As laughable as it seems now, Facebook (FB) once was a struggling public company with questionable prospects. But it climbed its way out — in part thanks to a gold mine in mobile apps.
To capitalize on this huge trend, the social network offered install ads, and the revenues exploded. In fact, depending on who you ask, they could account for half of all ad revenues. This has helped propel FB stock, which is up about 35% this year alone.
However, investors might want to be cautious. Mobile app advertising revenues aren’t etched in stone — and there are several reasons to worry about a deceleration, which would put Facebook stock in jeopardy.
Why Mobile App Ads?
First, some background.
Developers generally have a tough time getting users to download their mobile apps. App stores typically don’t provide a ton of prime real estate, and users typically only search through the first 20 or 30 results. To deal with this problem, developers spend money on install ads to get their apps in front of more eyes.
The issue? Return on investment is far from clear-cut. The market for mobile apps still is in relatively early stages, and mobile app ads even more so, which means the business is still highly experimental. Costs can be high for such campaigns, too — you have fees for the initial ad (which can run from $4 to $5 per install), but also follow-on ads to keep users engaged.
And even if the ads do work, there’s still the problem of whether the developers inking these deals have viable business models. For every Uber, you have numerous failures that have little idea about how to monetize their traffic. According to a report from MobileVision, 69% of developers do not generate enough revenues to pay a full-time coder. All told, “half (50%) of iOS developers and even more (64%) Android developers are operating below the ‘app poverty line’ of $500 per app per month,” according to TechCrunch.
Many of these developers pay for mobile app advertising through venture capital (interestingly enough, a large amount of this is from game developers). However, considering the poor performances of Zynga (ZNGA) and King Digital Entertainment (KING) and the difficulty of maintaining any sort of consistent returns in the space, it seems inevitable that VCs will lighten funding for game operators.
And that’s where Facebook would begin to feel the pinch.
At the same time, install ads for mobile apps probably have minimal interest from mega brands, which are the types of advertisers that FB covets. Hey, such companies have huge marketing budgets. But it seems fanciful that many users would be interested in clicking on an install ad for mobile apps from companies like GM (GM), McDonald’s (MCD) or American Express (AXP).
But there is another nagging problem for FB stock — that is, fatigue with mobile apps.
According to a recent study from comScore, only about a third of smartphone owners download any apps during an average month. Those who do typically download one to three apps.
In other words, most new mobile apps really don’t have wide breadth among users, which translates into few ways to squeeze significant money out of those apps.
One reason for the low participation is that Apple (AAPL) and Google (GOOG) have many of their own mobile apps already pre-installed apps. We’ve also come to a point where many users have already built loyalty for certain apps — so even when they buy new phones and begin downloading apps again, they’re usually the same ones they held on their previous phone.
While such trends are likely to mute growth of install ads, Facebook also will have to deal with more competition.
Perhaps the biggest threat is Twitter (TWTR), whose service seems ideal for app installs since users like to click on tweets. In fact, much of the recent spike in TWTR stock has a lot to do with the potential revenue opportunities from install ads.
All of this doesn’t imply that FB stock is poised for a big drop. Facebook has plenty of untapped potential in other properties such as Instagram and WhatsApp.
But any slowdown in app installs still would hurt growth, and that’s an issue when you consider that Wall Street is already pricing in perfection, with FB stock trading at nearly 100 times earnings.
So if you’re buying Facebook stock, just understand this very real risk of at least short-term turbulence should mobile install ad revenues hit a wall.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.