If you’ve been waiting on the sidelines for the right time to buy Facebook (NASDAQ:FB), you may be swayed by recent developments from the company.
However, nothing solidified the need to be cautious more than the recently unveiled graph search tool. The event had been hyped for more than a week and contributed to the stock’s run up to levels above $30 a share – a price it had not seen since July.
But the market took back much of those gains during intraday trading on Tuesday. While graph search may improve the user experience on Facebook, we don’t see how it could improve the company’s revenues in the near term.
Upgrade Instead of Downgrade
While Tuesday’s media event was widely disappointing for investors, other developments have positively affected Facebook’s stock. One came on Monday when Deutsche Bank upgraded it to buy from hold. Deutsche Bank analyst Ross Sandler is impressed with Facebook’s revenue momentum, noting that it is better than any other company the bank covers as it begins 2013. Especially important is Facebook’s advertising in the newsfeed of mobile users, which Sandler referred to as “the game-changer.”
Facebook Exchange Creating Gains
In the fall, Facebook unveiled Facebook Exchange (FBX), which allows marketers to use their own real-time consumer insight data to reach targeted audiences on Facebook. According to a ComScore study, Facebook represents more than 25% of the display ad inventory on the web.
Oppenheimer is so impressed with FBX that it raised its price target to $34 from $27. It also reiterated its Outperform rating on the stock. In the report detailing the reasons behind the increased price target, Oppenheimer analyst Jason Helfstein said it expected the fourth quarter of 2012 to be the first in which Facebook saw a meaningful contribution from FBX due to a larger number of people viewing the ads.
Ad Revenue Volatility
Although Oppenheimer raised its estimates on Facebook, it noted that the cannibalization from mobile usage may have slowed. On that news, the stock declined. Despite the overwhelmingly positive analyst reports on Monday, Facebook’s stock was down by about 2% in intraday trading. We think this reflects the uncertainty investors have about Facebook’s ability to generate earnings from advertising. This brings us to the company’s need to diversify its revenue stream.
Facebook has taken several steps to diversify its revenues with paid features. Take Facebook Gifts, for example, which Facebook rolled out last fall. TechCrunch estimates the service could lead to $1 billion a year in revenues. Facebook is also rumored to be working on a video-ad product that could be launched this year. If successful, Facebook could carve out a piece of the lucrative advertising market share advertisers spend on TV and radio.
Then there’s Sponsored Stories, ads that run in users’ newsfeeds. It is estimated to generate $1 million a day, or $365 million a year, with half of that coming from mobile users.
Facebook founder and CEO Mark Zuckerberg has maintained that the subscriptions to the site would always be free. However, the company saw relentless posting by die-hard Facebook loyals as a chance to make some more money. Posters determined to have their posts reach their “friends” can now pay $7 to have that post featured high in others’ news feeds.
Major Catalyst: 2012 Fourth Quarter Earnings
As the market gets over the disappointing reveal from Tuesday, players no doubt will be looking ahead to the Jan. 30 earnings report.
Overall we are optimistic, and think the potential growth outweighs the risks from factors we don’t understand yet. Investors were burned during the IPO, but interest and growth opportunities are abundant.
If options are too risky for you, wait until after the earnings report to decide if improved revenue streams make the company is worth its 50x valuation. Six months of strong growth after an IPO does not necessarily translate into a buy.
Recommendation: Buy FB under $33 per share following earnings on Jan. 30, 2013
Options Alternative: Buy March 31 calls for $2.10 per share or less before earnings
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.