Right about now it would be tempting for Facebook investors to take a victory lap. After a botched IPO and a year of queasy financials, the company finally posted a monster quarter, with revenue shooting up 53 percent to $1.8 billion behind big gains in mobile advertising. Facebook shares surged nearly 30 percent Thursday, and Facebook seemed poised to enter a new, much more optimistic era for its business.
But before the celebrations get too out of hand, let's take a look at how sustainable that revenue growth really is. Certainly a big chunk of Facebook’s income is healthy and repeatable, coming from long-term clients who have made serious commitments to the platform. But a lot of that business — Facebook executives won’t say exactly how much — comes from advertisements promoting mobile apps. Many of those
ads are short-term deals, purchased with venture capital as part of a land-grab to ramp up user bases. In other words, exactly the kind of ads that would disappear should the tech investment bubble burst.
Before investors dive into Facebook, they'll want to figure out exactly how reliant Facebook is on such ads, especially if they want to calibrate their exposure to potentially overheated startup investment flows. Carlos Kirjner, a sell-side stock analyst and early, prescient Facebook pessimist, says a thinning of the ranks among mobile app makers could hurt Facebook in a manner similar to the decline of Zynga, a videogame maker that once supplied 12 percent of Facebook’s revenue and which is now struggling just to keep its head above water.
“Many of these are startups trying to reach scale by advertising on Facebook may end up failing, and when they do demand could be reduced, ” Kirjner says. “The problem is that we don't know how important this was for Facebook's results.” And it's not because nobody's asking. Wall Street analysts specifically requested a breakdown of ad spending during a conference call this week, but Facebook stayed mum. Still, it's reasonable to assume that such ads drive a significant portion of mobile revenue—especially since Facebook executives referred to app install ads as a robust driver of growth.
“Revenue from mobile app install ads continues to accelerate,” COO Sheryl Sandberg said on the call. “We believe that Facebook is one of the most effective ways for [app] developers to acquire new customers at competitive rates. We’re increasing our share and helping to grow this market.”
Facebook co-founder and CEO Mark Zuckerberg reiterated the importance of mobile app ads later in the call, pointing to it as a key element of Facebook’s platform strategy.
“A lot of what we’re seeing is that folks have shifted toward using products like mobile app installs,” Zuckerberg said. “We had a little bit of skepticism about how happy developers would be with a system where they would pay to get more distribution. What we actually found is that… it’s the most stable way that they have to grow their apps.”
It makes sense that app startups and the people who fund them are happy to buy exposure through Facebook. But what happens when those apps either mature to the point where they don't need to pay for eyeballs, or go out of business trying to do so? For a while, there will be plenty of other startups ready to take their place. But that can't last forever. This week, Facebook proved that it had solved one problem—it figured out a way to survive the transition to mobile. But in doing so, it seems to have lashed itself more closely to the overheated startup economy. And that should give investors something to worry about, once they're done celebrating.
