Facebook goes from stock-market goat to lucrative moat

After botching its opening scene in the stock market, Facebook has turned things around for the second act.

The world’s most popular social media network was the object of skepticism and scorn after its initial public offering in May 2012. The shares started falling immediately and were down 50 percent within three months.

Old-schoolers like me questioned whether Facebook would ever be able to make money from its 1 billion users. Even a year after the IPO, some analysts said Facebook would have trouble selling advertising on mobile devices, which increasingly were the way people accessed its site.

Everybody’s taking back those comments now. When Facebook reported its second quarter earnings on Wednesday, it said ad revenue grew 67 percent. Those once-elusive mobile ads make up nearly 60 percent of total revenue, and Facebook is making money.

Profit margins, in fact, are high and rising. Facebook looks like a classic moat builder: Its users, who now number 1.3 billion, are a competitive advantage that other ad sellers may never be able to overcome.

In the stock market, Facebook has won over the skeptics. The shares shot up 5 percent after the earnings report and closed the week at $75.19, nearly double the $38 IPO price and quadruple the August 2012 low.

Brian Wieser, an analyst at Pivotal Research Group in New York, had a “sell” rating on the Facebook IPO, and a “hold” rating on the shares afterward. He switched to a “buy” in early 2013 and remains enthusiastic.

“They’ve put up spectacular numbers, both top line and bottom line,” he said.

What has changed since the early days? Basically, the cash register has started ringing. “It wasn’t entirely clear how committed to commercializing the platform the company was,” Wieser says. “They’ve gone from having a good consumer product to being a really good business.”

Norman Conley, chief investment officer at JAG Capital Management in Ladue, was also an early Facebook skeptic. “I just didn’t get my arms around Facebook’s valuation back then,” he said. “I saw it as being very unlikely they would monetize that user base.”

He’s also been surprised by the company’s dominance in mobile advertising. Of every hour that Americans spend using their mobile devices, about 12 minutes is spent on Facebook.

“They were struggling in mobile, it was a problem, and they clearly have fixed it,” Conley says.

Conley says he now sees Facebook’s potential, but hasn’t bought the shares. One reason is that they’re getting pricey, at 71 times Wieser’s estimate of this year’s earnings.

By comparison, Google sells for about 21 times earnings estimates.

When a company is changing as fast as Facebook is, traditional valuation methods aren’t very useful.

It will take years of future profits to justify today’s stock price, and the company will probably look much different in a couple of years. Acquisitions such as Instagram and WhatsApp might deliver new revenue streams, or they might turn out to be costly diversions.

One thing’s for sure: The company’s success is making people forget about its disastrous IPO.

Coincidentally, Facebook said this week that the Securities and Exchange Commission dropped its investigation into that offering, which was plagued by trading glitches and allegations about selective disclosures.

As it turned out, an investor who bought the shares early and held them through all the difficulties has done quite well. Perhaps the SEC’s guiding principle was no harm, no foul.

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