Facebook Profit Shows Existential Risk for Social Network

Jan. 3 (Bloomberg) -- Bloomberg's Dominic Chu looks at Facebook stock and what is fueling a nearly 60 percent rally off lows reached in September. He speaks on Bloomberg Television's "In The Loop."

As Facebook Inc. (FB) explores a broader range of money-making businesses, such as video ads and music streaming, it will need to shake off the growing pains that marked its first quarters as a public company.

Slowing revenue growth and sagging shares have ratcheted up pressure on Facebook to find new ways to generate sales. At the same time, the world’s largest social network will have to assuage concerns about privacy rights, woo investors and stay true to Chief Executive Officer Mark Zuckerberg’s pledge that Facebook is more a social movement than a business.

“It’s a fine line that they have to straddle,” said Victor Anthony, an analyst at Topeka Capital Markets Inc. “It’s all part of the growing pains.”

Instagram, Facebook’s photo-sharing business, incited a backlash last month by fueling concern that it would sell users’ images to advertisers without consent. Facebook also ran afoul of privacy advocates last month after a shift that gave users less voting control over changes to privacy and data-collection policies.

As the company harnesses data posted by its more than 1 billion users to help advertisers market wares, Zuckerberg risks alienating consumers and compromising his stated goal of making the world “more open and connected.” Facebook has already come under scrutiny by regulators in Europe and the U.S. amid concern it hasn’t done enough to protect privacy.

Though the stock has pared some losses since September, Facebook’s shares are down 26 percent since its May initial public offering as investors seek evidence that the company can step up advertising-sales growth. Facebook needs more money- making ad products, and it’s finding user backlash a tough obstacle, said Rich Greenfield, an analyst at BTIG LLC in New York.

‘Body Language’

“How much advertising can they push without upsetting the user?” Greenfield said in an interview with Bloomberg TV last month. “You have seen a dramatic change in body language out of the company. Now, they have really focused on monetization.”

Analysts on average are projecting more slowing this year. Revenue may rise 30 percent to $6.53 billion in 2013, compared with estimated 35 percent growth last year, according to data compiled by Bloomberg. Sales leaped 88 percent in 2011. Sales of virtual goods for games such as Zynga Inc. (ZNGA)’s FarmVille, once considered a hot area of growth, declined in the third quarter from the prior period.

Facebook is “just getting started” on new paid products, Zuckerberg said during a third-quarter earnings conference call. Every product group is asked to generate ideas on how to bring in revenue, he said at the time.

Mission, Money

Making money hasn’t always been Facebook’s top priority, according to Zuckerberg.

“We don’t build services to make money,” he wrote in regulatory filings outlining Facebook’s IPO plans. “We make money to build better services.”

“Facebook was not originally created to be a company,” Zuckerberg, 28, wrote. “It was built to accomplish a social mission.”

Still, Facebook has already shown that it can quickly and successfully introduce new products. Shares have rallied 60 percent since slumping to a low of $17.55 in September on signs that mobile-ad growth is accelerating. Facebook debuted mobile tools last year to take advantage of faster user growth on wireless devices.

Facebook is expected to report $339.3 million in U.S. mobile ad revenue for 2012, up from zero the prior year, according to research firm EMarketer Inc. In 2014, Facebook’s U.S. mobile ad revenues may exceed $1.2 billion, grabbing 11 percent of the market, the researcher said.

Revenue Generators

Video advertising, music and video streaming services, expanded payment services and a social search engine are among additional revenue-generating features Facebook may choose to roll out.

“It’s not a nonprofit,” said Brian Wieser, an analyst at Pivotal Research Group LLC. “They are looking for lots of ways to make money. You have to expect they’ll want to try hundreds of things.”

Wieser said Facebook could sell video ads, a market that will reach more than $8 billion in 2016, compared with $2.93 billion last year, according to EMarketer.

The social network might also seek to follow Amazon.com Inc.’s and Apple Inc.’s moves in selling music and offering movie rentals, Wieser said.

“These are forms of content distribution that could benefit from social,” he said. “It’s very realistic that they could choose to go there.”

Gift Offers

Another money-making venture may lie in Facebook’s Gifts feature. The social network could generate revenue from suggesting purchases related to user posts, said Martin Pyykkonen, an analyst at Wedge Partners Corp. Someone posting photos from a ski trip, for instance, may get offers for a lift pass or a new pair of skis.

“The biggest opportunity is Gifts,” Pyykkonen said. “It’s going to become bigger and bigger.”

In the process, Facebook could streamline payments for goods sold through its site, and compete with online-payments provider PayPal, Scott Kessler, head of technology equity research at S&P Capital IQ, said in an interview.

“It could make the payment mechanism simpler,” Kessler said. Today, Facebook lets people use PayPal or credit cards to buy credits for virtual weapons and coins within games that run on the social site. It could facilitate payments directly, gaining a cut of each transaction, he said.

Search Engine

Another option is to introduce a search engine, which would let users conduct Internet queries without leaving Facebook’s own site, Topeka Capital Markets’ Anthony said. This would mean Facebook could sell search-related ads, similar to Google Inc.’s model.

“That’s one of the catalysts for 2013,” he said. “I know they are working on it. I see this as a huge opportunity.”

At the TechCrunch Disrupt conference in September, Zuckerberg hinted that Facebook is looking at offering a Web search engine through the social network. Facebook could grab 5 percent of the U.S. search advertising market, which reached about $15 billion in 2012, within a year of introducing such a product, said Karsten Weide, an analyst at IDC.

As Facebook steps up the pace of feature introductions, it will need to avoid making the efforts appear too commercial, lest it put off users, Kessler said.

“You could see a degradation of growth in the face of more monetization-related activities,” he said.

Some efforts to generate income also encroach on users’ privacy, Kessler said, raising the risk of backlash.

Instagram Backpedals

In December, an attempt to change the terms of service of Instagram -- the photo service Facebook acquired in 2012 -- suggested the application might let marketers use photos posted by users. That drove some members to competitors, including Yahoo Inc.’s Flickr, in protest, and resulted in a class-action lawsuit. Days later, Instagram removed the new language from its terms, due to take effect this month.

As Facebook enters 2013 seeking to balance the demands of both investors and members, one notable user weighed in on the predicament facing members who want to share information with friends, yet are worried about keeping their data private.

A recent holiday photo posted on Facebook by Randi Zuckerberg, Mark Zuckerberg’s sister, was spread via Twitter Inc.’s microblogging service after it was seen by another user with access to the picture based on the social network’s privacy settings. The photograph was taken down after a brief public spat.

“Digital etiquette: always ask permission before posting a friend’s photo publicly,” Randi Zuckerberg wrote in a later Twitter post. “It’s not about privacy settings, it’s about human decency.”

To contact the reporter on this story: Olga Kharif in Portland at okharif@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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