Facebook Profit Drops as Spending Rises on New Features

Jan. 31 (Bloomberg) -- Bloomberg's Jon Erlichman reports on Facebook CEO Mark Zuckerbrg's new view on ads as the company made long-awaited progress luring advertisers eager to reach mobile-device users. He speaks on Bloomberg Television's "Market Makers."

Facebook Inc. (FB) reported a plunge in fourth-quarter profit on higher spending, even while it made long-awaited progress luring advertisers eager to reach mobile- device users.

Net income fell 79 percent to $64 million last quarter as operating expenses jumped 82 percent, Facebook said yesterday. That outpaced a 40 percent revenue gain to $1.59 billion and raised concerns that margins will come under pressure. The stock fell as much as 8 percent as investors weighed near-term lower profit against the prospect of future growth.

Chief Executive Officer Mark Zuckerberg plans to increase expenses, excluding certain costs, 50 percent this year to hire staff and roll out new tools for advertisers. That’s more than the 33 percent increase projected by Pacific Crest Securities LLC, and it underscores the urgency of capturing a bigger slice of the $6.97 billion U.S. mobile-ad market. Done right, the added investment will translate to profit growth, said Adam Schneiberg, a portfolio manager at BTR Capital Management.

Wall Street tends to be forgiving of higher spending during high-growth periods when new products are being built,” Schneiberg said. “As long as eyeballs tune in and revenue keeps growing, the Street will believe that at some point the company can flip the switch on profitability.”

Photographer: Daniel Acker/Bloomberg

Facebook spent more to roll out new ad services, including mobile, in the past year as it grapples with rising competition for marketing dollars from larger rivals. Close

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Photographer: Daniel Acker/Bloomberg

Facebook spent more to roll out new ad services, including mobile, in the past year as it grapples with rising competition for marketing dollars from larger rivals.

Facebook, based in Menlo Park, California, retreated 6.9 percent to $29.10 at 9:35 a.m. in New York, and earlier touched $28.74 for the biggest intraday decline since Sept. 24. Through yesterday, the stock had climbed 76 percent from a record low close on Sept. 4.

Mobile-Ad Push

Facebook’s increased investment is designed to help the company grapple with rising competition from larger rivals in the U.S. market for mobile advertising, predicted by EMarketer Inc. to surge 82 percent this year. Google Inc. (GOOG) is projected to grab 57 percent of that market, and Facebook will remain a distant No. 2 with 12 percent, EMarketer estimates.

“More mobile revenue means way more spending on the operations of selling ads,” said Brian Wieser, an analyst at Pivotal Research Group LLC, who today upgraded his rating on the stock to buy from hold and raised his prise estimate to $36 from $30. “This is an expensive company to run.”

Mobile contributed 23 percent of total advertising revenue, or about $306 million, according to Facebook. That compares with 14 percent in the third quarter. Analysts at JPMorgan Chase & Co. predicted mobile would contribute $384.2 million, or 27 percent of ad revenue, in the latest quarter.

‘Big Transition’

Facebook’s engineers are making improvements to mobile applications, including those for Google’s Android software, Zuckerberg said on a conference call. Better mobile services can boost user engagement, he said.

“We made this big transition, where now there are more people using Facebook on mobile every day than on desktop,” Zuckerberg said. “More people are starting to understand that mobile is a great opportunity for us.”

Profit excluding some items was 17 cents a share. That compares with analysts’ prediction for 15 cents. Analysts had projected $45.8 million in profit on sales of $1.52 billion, according to data compiled by Bloomberg.

Facebook is investing in new products to attract users and keep them on the site longer. Earlier this month, the company announced a revamp of its search service that lets members find information on people, places, photos and interests. The company also has upgraded its mobile applications with new versions for phones running Google’s Android software and Apple Inc. (AAPL)’s iPhone.

‘Investing Heavily’

“We’re investing heavily because we see big opportunities ahead for the company,” David Ebersman, Facebook’s chief financial officer, said in an interview. “So, we’re trying to invest to build the most valuable company we can for the long term and to really invest in areas that can drive engagement.”

Zuckerberg also said that he expects to hire aggressively, causing expenses to grow at a faster rate than sales in 2013. The company had 4,619 employees at the end of last year, according to data compiled by Bloomberg.

Facebook’s fourth-quarter operating margin declined to 33 percent from 48 percent a year earlier, while costs rose to $1.06 billion from $583 million.

“Facebook will continue investing in technology and engineering resources to drive growth, tempering margin expectations,” said Colin Sebastian, an analyst at Robert W. Baird, wrote in a research report today. He rates the shares the equivalent of buy with a target price of $34.

User Growth

Facebook reached 1.06 billion users during the fourth quarter, up from 1.01 billion in the third quarter. The number of mobile users was 680 million, up from 604 million in the third quarter.

Analysts had been pushing up ratings amid growing optimism for accelerated revenue growth. Through yesterday, the proportion of analysts covering Facebook with a buy rating had risen to 65 percent from 52 percent on Oct. 23, when Facebook posted third-quarter sales that beat estimates, according to data compiled by Bloomberg.

“A lot of these products are pretty new,” said Scott Kessler, an analyst at S&P Capital IQ, who rates the stock a hold. “It’s just going to take some time.”

To contact the reporter on this story: Brian Womack in San Francisco at bwomack1@bloomberg.net

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

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