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What Does Facebook Need to Do to Get Turned Around?

It was a relatively short time ago that Facebook (FB) was considered to be the hottest tech company around. Leading up to the company's IPO earlier this year, Wall Street was in love with the social network and the only uncertainty surrounding the stock was how high it would trade.

In the months leading up to the IPO, analysts hailed the stock as the next Google (GOOG), but so far that has been the furthest thing from the truth. The debacle that we have seen with Facebook appeared to start before trading even started and the stock has seen its value continue to erode since its May launch.

The company will get a chance to impress Wall Street when it reports third-quarter results after the market closes this afternoon. Last quarter the company reported that revenues were up slightly over 32% versus the same period last year, but the company lost 8 cents per share due to higher costs and higher-than-expected expenses.

Since Facebook is so often compared to Google, let’s begin by taking a look at Google’s earnings, which it reported last Thursday. The search giant missed its earnings estimate by a wide amount, posting $9.03 per share, well below the $10.65 analysts expected.

Why did Google miss by such a large amount?

You can come up with numerous ideas as to why you think Google’s earnings were so weak, but perhaps it is best to look at the most obvious. The biggest change that has taken place at Google over the past year is the massive changes it has made to its basic search algorithm. The so-called “Panda” update rolled out last year and left devastation in its wake. 

Panda was designed to improve search results, but it seems to have backfired, and it resulted in mass traffic losses for some of the biggest, most established sites on the web. While the stated objective may have been to improve search, a more sinister possibility could have been that it was attempting to force advertisers to spend more money on paid clicks. If this was Google’s plan, it did not work, and advertisers did not boost their budgets, mainly because the loss of organic traffic had a big impact on the money they had available for advertising.

There is also the problem of mobile advertising, and this is where we can look for hints at what to expect from Facebook. Both companies are trying to deal with the increased use of mobile devices, and the difficulties that come with trying to monetize mobile users.

Google announced that the cost-per-click rate that advertisers pay declined by 15% from the same period last year. This is solely a result of increased mobile traffic.

Google not only dominates the PC search market, but it also has a solid grip on the mobile market, and if Google is having a hard time making money on mobile users, then you can be sure the same is happening with our friends at Facebook.

The other search engine giant, Yahoo! reported its third quarter results last night, and reported much stronger-than-expected results, but a big part of that is a result of the sale of its stake in Alibaba.

Yahoo! CEO Marissa Mayer has said that boosting its mobile presence is a top priority, but so far the company has yet to capitalize on the booming mobile market. The difference in Yahoo versus Google and Facebook is that the latter two are grappling with ways to monetize their mobile traffic while Yahoo is struggling to increase its mobile traffic, so there is not much about Facebook that we can learn from Yahoo.

Mobile revenues are going to continue to weigh on Facebook, but that is something everyone already knows, and no one expects to hear a clear plan as to how the company plans to improve mobile revenues just yet.

So what can Facebook say to get traders interested in the stock again?

1. A slowing of expenses.

During the last conference call, the company said it was spending a lot of money on growing its business, including massive spending on new servers. This has really hurt the company’s margins and investors want to hear when this spending is going to slow down.

In addition to boosting its infrastructure, the company is dumping huge amounts of cash into research and development. It is expected to report much higher expenses this quarter than it did for the second quarter and Wall Street is going to want to hear how long it expects to see these sort of expense jumps.

Facebook is in a tough position because it has to research and develop new ways to boost revenues, but investors are not going to be patient and will expect to see these added expenses result in higher earnings sooner than later.

2. More detailed information on actual users.

While it is nice to see that Facebook has over 1 billion users, that number means nothing to investors. There is no way to audit these users to know how many are actually using the site on a regular basis.

There are a lot of people who have multiple accounts and a lot of spam accounts that should not be included in the member numbers that Facebook reports. There is a great deal of spam usage on the site, and Facebook will most likely continue to just report the highest numbers possible in order to avoid a major sell off should the actual number of users be closer to a half billion, most of which hardly use the site.

This is once again a tricky situation for Facebook. Wall Street would love to see more accurate numbers, but Facebook is probably doing the right thing by just reporting the highest number they possibly can. If Facebook can somehow offer numbers that were still impressive while also being more transparent, the stock would get a boost.

3. Positive update on Facebook gifts.

The one day of the year when every Facebook user loves looking at their wall is on their birthday. This is the day when everyone stops by to wish you a happy birthday, and Facebook has taken notice of this, recently introducing Facebook Gifts.

The program allows users to buy and send presents to one another. Items such as Starbucks gift cards, stuffed animals and cupcakes were among the first items available in the gift shop, and Facebook plans to continuously add more options.

This is a smart move, and could result in a much-needed solid revenue stream.

Another long running concern that analysts have with Facebook is the inexperience of its young leader, Mark Zuckerberg. He needs to present himself well on today’s conference call and display leadership and poise during his remarks.

Wall Street is already completely aware of the problems that Facebook faces and one quarter's results will not be enough to change anyone's impression of the company. What investors really want to hear is what Facebook is doing to improve its business in the future. The potential is there, but Facebook has to capitalize on it. Until it can show analysts concrete steps that are being taken, the stock will never live up to its pre-IPO expectations.

 

 photo credit: lev radin / Shutterstock.com

 

Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va. His articles typically cover big-picture events and forecasting what impact they will have on the stock market. In addition to writing for Fresh Brewed Media, Michael also wrote for AOL's BloggingStocks for three years, focusing most of his attention on the energy and technology sectors.

 

Michael Fowlkes

Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va.