Facebook's Ad Business Is Doing Great, But Teen Engagement Is Becoming a Problem

Total Revenue Grew 60% to $2.02 Billion, Exceeding Expectations

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It was a good news-bad news quarter for Facebook.

First the good: Facebook's ad business is firing on all cylinders. The company handily beat estimates on profit and revenue. Prices for its news-feed ads are climbing. And Facebook is now getting 49% of its revenue from mobile, up from 14% a year ago.

Then this: for the first time, Facebook conceded that engagement among teens has been dropping off. A quarter-over-quarter decline in daily usage by younger teenagers was observed, which could bode poorly for Facebook as it competes with Twitter, Snapchat and a plethora of messaging apps vying for people's attention.

Mark Zuckerberg
Mark Zuckerberg

The stock had a whipsaw night after-hours, rocketing up 16% after the numbers came out, and then falling back to earth some 90 minutes later after the disclosure about teens. In all, it was an $10 swing.

The initial exuberance was expressed when the initial results were posted. After a year of demonstrating robust growth of its mobile ad business, Facebook has almost reached the tipping mobile. Revenue from mobile accounted for 49% of its ad revenue in the third quarter.

Once flagged as the biggest risk factor for the social network leading into its initial public offering, mobile is now a core strength fueling the company's revenue growth, driven by the adoption of news-feed ads. While behemoths like Google and Yahoo are struggling with mobile, Facebook appears to be coasting.

The acceleration of Facebook's mobile ad revenue is critical in light of the fact that the company acknowledged that its daily active user base on the web declined over last year, "albeit slightly," according to chief financial officer David Ebersman.

On mobile, Facebook had 507 million daily active users on average in September and 874 million active monthly users, an increase of 45% over last year. Chief Operating Officer Sheryl Sandberg characterized the change in usage as a business opportunity for Facebook.

"We believe this shift will continue, and will continue to benefit us," she said.

Overall revenue climbed to $2.02 billion, up 60% from last year's $1.26 billion. Advertising comprised more than 89% of that total, with the balance coming from payments and fees. Net income was $425 million, compared to a net loss of $59 million in the third quarter of 2012.

Adoption of news-feed ads
While describing the strong growth of mobile ad revenue quarter over quarter, Mr. Ebersman also said that desktop ad revenue was sequentially down. Revenue from desktop news-feed ads was up, "but not enough to offset the revenue decline from the right-hand column," he said.

Though the right rail -- which fetches lower prices than news feed ads -- is still widely used by direct-response advertisers, the overall percentage of spend invested in it appears to be in steep decline. According to Marc Grabowski, chief operating officer of the social-ads company Nanigans, 79% of the Facebook spend managed by his firm in the third quarter was invested in news feed. (The figure is especially significant when you consider that a large portion of Nanigans clients are in direct-response-oriented categories like e-commerce, online gaming and travel.)

While adoption of news-feed ads has been key to Facebook's revenue growth, the refinement of its measurement products has also played a large role. Partnerships with companies like Nielsen and Datalogix -- which collects loyalty data and can track purchases for CPG companies -- have spurred marketers to up their spend on Facebook, since they have a better notion of what that investment will yield.

"It's certainly peaking marketers' interest and making them more willing to spend," said Sarah Hofstetter, CEO of 360i.

Teen flight?
The big question came when Mr. Ebersman revealed for the first time that engagement with Facebook by younger teens is down, but how much is hard to discern because of the lack of precision in gauging the age of that demographic.

"We're pleased that we remain close to fully penetrated among teens in the U.S. … and overall engagement remains strong," he said.

Nevertheless, the revelation hit Facebook shares hard, sending them down in after-hours trading, and posing a new question the company will have to answer: is Facebook just your parents social network?

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