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Thursday, July 25, 2013

Facebook’s Stock Soars Amid Rosy Growth Expectations

Facebook’s stock levitated nearly 30 percent on Thursday, to $34.36 a share, after a second-quarter earnings report that was far stronger than Wall Street had predicted.

Securities analysts raised their revenue and profit estimates and stock-price targets for the social networking company, which has seen sentiment about its prospects swing widely since its initial public offering at $38 a share in May 2012.

Even the bears were impressed with the company’s second-quarter performance. Richard Greenfield of BTIG Research, who had long recommended that investors sell Facebook’s stock, put out a report on Wednesday declaring, “We were wrong.”

In an interview on Thursday, Mr. Greenfield said: “The reality was that I don’t think I’ve ever raised my estimates on a company of this size by that much. They literally crushed my expectations.”

The big rise in the company’s mobile revenue, to 41 percent of its total ad revenue, is the principal factor driving the change in perceptions, as I explored in an article in Thursday’s Times.

But investors also seem to be giving Facebook more credit for its growth potential than they were in the past. Mr. Greenfield, for example, now predicts that the company will have revenue of $9.3 billion next year, up from his previous estimate of $7.4 billion.

Facebook, which has about 1.2 billion users worldwide, said it has more than one million active advertisers, including all of the biggest global brands â€" a doubling from a year ago. The company said it sees great opportunity in reaching out to small local businesses, which are getting simplified tools to run ads, as well as in offering more sophisticated tools for big consumer brands.

Sheryl Sandberg, Facebook’s chief operating officer, said that 88 million to 100 million people are on Facebook during primetime TV hours in the United States.

“I think what that shows is the size and engagement of our audience,” she said in an interview on Wednesday.

Facebook’s Home suite of applications for Android smartphones has so far failed to get any traction with users, so ads are not a priority there.

But Ms. Sandberg pointed to initiatives like Facebook for Every Phone, which has brought the social network to 100 million users of basic cellphones. Although ads are just beginning on the service, she said they are already appealing to advertisers because “there is not really an easy way to reach people in the developing world.”

And it’s only a matter of time before Facebook starts including ads in Instagram, its popular photo and video sharing service.

Aaron Kessler, an analyst at Raymond James brokerage firm, said that the huge stock price increase on Thursday reflected Facebook playing catch-up.

“Facebook has underperformed basically all year,” said Mr. Kessler, a fan who had a strong buy on the company’s stock before the earnings came out and just raised his price target to $38.

Still, there are reasons to be cautious. One concern, said Mr. Kessler, is how engaged users are with the service. A measure widely followed by Wall Street â€" the ratio of daily active users to monthly active users â€" rose slightly to 61 percent.

“But teenagers are relatively flat in the usage,” he said.

During a conference call with analysts on Wednesday (transcript here), Mark Zuckerberg, Facebook’s chief executive, acknowledged that trend, but added, “Instagram is growing quickly as well. So if you combine the two services together, we believe our engagement and share of time spent are likely growing quickly throughout the world.”

Much of the company’s advertising revenue growth is coming from price increases, not the sale of more ads, Mr. Kessler said. If Facebook does start serving up more ads to users, especially irrelevant ads, there is a risk that users will get turned off. (Mr. Zuckerberg said the company was closely monitoring that.)

Finally, there is the tyranny of comparisons. Investors typically focus on a company’s year-over-year growth.

Ads in the news feed and from mobile ads, which drove much of the second quarter’s growth, basically didn’t exist in the second quarter last year, so their growth rates were fantastic. Going forward, year-over-year percentage growth will almost certainly be smaller.

David Ebersman, Facebook’s chief financial officer, uttered a word of caution to that effect in Wednesday’s call with analysts.

“Remember that News Feed ads really began to contribute to our revenue in the third and fourth quarters last year, which will make for more difficult year-over-year comparisons in Q3 and Q4 relative to Q2,” he said.

In its quarterly financial filing with securities regulators on Thursday, Facebook put it even more starkly, “We expect that our user growth and revenue growth rates will decline over time as the size of our active user base increases and as we achieve higher market penetration rates. As our growth rates decline, investors’ perceptions of our business may be adversely affected.”

In other words, beware irrational exuberance.