Explosive Growth In One Key Metric Shows Why Facebook Is Headed Higher

Remember when Facebook stock was trading at $18 and everybody was worried that the company had lost the mobile market? In hindsight, that would've been a great time to buy the stock. Foolish investing is not about timing the market, however, it's about making an investment that has great long-term potential. To me, Facebook's latest earnings results show a small glimpse of that potential.

Breakout second quarter
Facebook's second-quarter results surprised everyone. The social-networking giant reported that its revenue grew 53% year-over-year, a sharp acceleration from the 38% growth in the previous quarter. The question arises: Where did this acceleration coming from?

Broadly speaking, there are two sources of Facebook's revenue growth. First, the growth can come from growing user base. Second, Facebook's revenue grows if it can extract more money from each user.

The chart below shows the year-over-year growth in Facebook's monthly active users (MAUs) over the past two years.

Source: Company SEC Filings

You can see from the chart that the strong initial growth rate has been gradually falling, and has stabilized in the 20-30% range for the past four quarters. Facebook penetration in developed markets is reaching its peak, and most of the user growth is coming from emerging markets where advertising rates are generally lower. This means that user-base growth has not been the primary driver of the recent surge in revenue.

This brings us to the key metric that is driving the rising revenue: growth in average revenue per user (ARPU), which is shown in the chart below.

Source: Company SEC Filings

The chart above explains a great deal about Facebook's story so far. After showing strong growth in the first three quarters of 2011, the ARPU growth fell off a cliff in fourth quarter. It even dropped below 5% in the second quarter of 2012. This was the period when Facebook's desktop usage was declining and mobile usage had started to surge, but Facebook had still not started monetizing its mobile users.

That all changed in mid-2012 when the company ramped up its mobile monetization strategy. The company's mobile News Feed and App Install ads have been a huge success; in its latest results, Facebook reported that mobile ad revenue accounted for 41% of its total advertising revenue.

In fact, Facebook's mobile ad sales are growing so rapidly that it has market leader Google worried. Digital marketing researcher eMarketer estimates that the overall mobile ad market will grow 89% in 2013 to $16.65 billion. EMarketer estimates that Google's share of the mobile ad revenue will remain stagnant at 53.2% in 2013 as compared to 52.4% in 2012.On the other hand, Facebook's share of the mobile ad revenue is expected to almost triple, from just 5.4% in 2012 to 15.8% in 2013.

That is a remarkable achievement from Zuckerberg and his team as it has barely been a year since Facebook introduced mobile monetization.

You can see from the chart that soon after Facebook introduced its mobile monetization strategy, the ARPU growth started to accelerate, and grew an explosive 25% in second quarter of 2013.

There's more growth to come
It doesn't stop here; Facebook can keep earning more money from its users for a very long time.

One of the most promising upcoming ad products that could boost ARPU even further is the highly lucrative video ads, which could be playing on the News Feeds of hundreds of millions of users as soon as fall this year. The Wall Street Journal estimates that video ads could fetch Facebook $2 million per day, while Bloomberg believes that Facebook could get as much as $2.5 million per day for each video ad.

In addition to video ads, another source of increase in the Facebook's revenue could be the monetization of its $1 billion acquisition, Instagram.

In the second quarter earnings conference call, CEO Mark Zuckerberg told us that Instagram had over 130 million MAUs and that this number is still growing rapidly. Since Instagram's content is primarily photos and videos, I believe that any Instagram ads would be highly engaging and will carry relatively higher prices. As a result, successfully monetizing Instagram could give Facebook a huge revenue boost in the near future.

There is Facebook's potential entry into the mobile payments market which is currently dominated by eBay's PayPal.

According to AllThingsD, Facebook is testing an online payments product that would allow users to shop on mobile apps using their Facebook login information instead of tediously entering billing details with each purchase. Although Facebook is staying away from payments processing for now, it could very well rival PayPal for a piece of the rapidly growing mobile payment processing market in the future.

Moreover, widespread adoption of an online payments product could give Facebook valuable information about users' shopping preferences. This could then be leveraged for better ad targeting, resulting in higher ad pricing.

Foolish advice
For Facebook investors, the number one question has always been whether the social networking giant will be able to successfully monetize its 1.1 billion users. In my opinion, the strong acceleration in ARPU growth tilts the answer to that question toward "yes."

The remarkable performance of Facebook's mobile monetization strategy gives me confidence that the company will be able to successfully integrate video ads, monetize Instagram and potentially implement mobile payment processing at some point in the future. This is why I believe that Facebook could be a good long-term buy for Foolish investors.

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The article Explosive Growth In One Key Metric Shows Why Facebook Is Headed Higher originally appeared on Fool.com.

Zain Zafar has no position in any stocks mentioned. The Motley Fool recommends eBay, Facebook, and Google. The Motley Fool owns shares of eBay, Facebook, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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