How Facebook's Revenue Is at Risk

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Facebook's (NAS: FB) IPO glow sure didn't last long, with shares promptly plunging on their second public day. There are plenty of other risks looming on the horizon, most notably increasing advertising rivalry from top dog Google (NAS: GOOG) and social gamer Zynga's (NAS: ZNGA) obvious interests in broadening its horizons. In addition, will Facebookers stay engaged forever?

When all else fails -- advertise!
We can break down Facebook's current figures for deeper insight. We know that the majority of Facebook's "payments and other fees" revenue comes directly from Zynga. We also know that of Zynga's player base, a disproportionately small number of players actually contribute to sales, and these players are affectionately known as "whales," just like the high rollers in Vegas.

Last quarter, Zynga had only 3.5 million paying players out of 182 million monthly unique users, or MUUs. That's just 1.9% of the MUU base willing to pay up.


By that rationale, an even smaller fraction of Facebook's overall MAU base actually contributes to the "payments and other fees" revenue, inflating the average revenue per user, or ARPU, for the rest of us who will never heed the call of a virtual tractor in FarmVille. I've never paid a cent for anything on Facebook's platform, and I never will. On top of that, Zynga is assuredly interested in eventually moving away from Facebook's payment platform in favor of its own.

Backing out the payments segment and focusing on the core advertising business is useful for both of these reasons.

Here's what happens to worldwide and North American (the segment with the highest monetization) ARPU if you back out payments revenue, which effectively looks at average advertising revenue per user.

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Source: prospectus. Author's calculations.

Source: prospectus. Author's calculations.

That shows you just how much ARPU downside there is if payments revenue, which looks very much threatened right now, goes away.

Facebook had better find that next big moneymaker quick.

Y'all come back and see us, y'hear?
Some have called Facebook a fad. Nearly half of the 1,000 respondents to a recent CNBC survey considered it a temporary trend. While 1,000 people is hardly a representative sample, the skeptics are clearly out there.

To really gauge the health of Facebook's user base, investors will be looking at some of its key metrics. There are a few ways to see just how engaged Facebookers are. The most obvious ones are how many MAUs, and daily active users, or DAUs, there are while tracking the mix.

anImage

Source: prospectus. Author's calculations.

Source: prospectus. Author's calculations.

MAU growth is important, but it's also a good sign if more of these users are logging in on a daily basis. The more frequently they log in, the more engaged they are, and the more ads you can sell. That trend is certainly heading in the right direction.

Of total MAUs, mobile MAUs also make up an important subset to keep an eye on, because mobile largely isn't monetized. Facebook is up to 488 mobile MAUs, and of these it estimates that 83 million --over 9% of the total MAU base -- exclusively use the mobile app, meaning that these users don't contribute much to the top line.

At this point, we've seen that a small fraction of users carry the bulk of payments revenue, and an increasing portion use a non-monetized platform.

The newest Wall Street metric: "likes"
Facebook also tracks "likes" and comments and has given us two quarter's worth of metrics. In the fourth quarter, users generated an average of 2.7 billion "likes" and comments per day, and that figure rose to 3.2 billion in the first quarter. As silly as it sounds, this may prove to be an important metric to keep an eye on, because it's a proxy for how engaged the user base is.

Many companies have industry- or company-specific metrics that the Street looks toward, and Facebook's will likely be "likes." Just imagine this hypothetical conference call Q&A that might materialize within the next few years:

Analyst: Congrats on the quarter, but I couldn't help noticing that this quarter's "likes" came in a little light at 4.6 billion, which is down 8% year over year and 2% sequentially, and missed the consensus of 4.7 billion "likes." Can you add some color to what's driving that downtrend in "likes," and do you think there's cause for concern? How should we be adjusting our "likes" modeling going forward? I also have a follow-up.

Mark Zuckerberg: Well, there are a couple of factors driving that. There is some "likes" seasonality, and fourth-quarter "likes" tend to be lower because of the holidays, since people spend more time with family and traveling as opposed to on the site. We've also been testing out some new monetization features that users didn't like, so that may have had an adverse impact on "likes" activity. Also, keep in mind that average "likes" per user (ALPU) was about flat, so a lot of that "likes" drop-off is related to user attrition to Zynga's platform. We're rolling out some new engagement initiatives this quarter, so I think we'll start seeing "likes" organic growth trend higher again.

Sounds absurd, right? Well, at this rate I wouldn't be too surprised if something like that exchange comes to fruition one of these days, although I haven't the faintest idea how you'd model "likes" growth.

Facebook: Not future-proof
Both of Facebook's revenue sources are at risk. Advertising will see pressure as Google kicks up the competition and users increasingly use mobile apps, while payments are tied to Zynga, which is looking for the exit. Keeping users engaged will just be part of the battle.

Facebook needs to boost international monetization if it ever hopes to dominate the world. In the meantime, here are three American companies already set to dominate the world by tapping into emerging-market growth. Grab a free copy of this report to read more.

At the time this article was published Fool contributorEvan Niuholds no position in any company mentioned. Check out hisholdings and a short bio. The Motley Fool owns shares of Google.Motley Fool newsletter serviceshave recommended buying shares of Google. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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