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By Jeremy Glaser and Rick Summer, CFA, CPA | 05-15-2012 01:30 PM

Facebook a Future Advertising Force

Morningstar's Rick Summer sees Facebook and Google dominating the Internet advertising market as Facebook finds better ways to monetize its massive user base.

Securities mentioned in this video
FB Facebook Inc
GOOGL Google Inc

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Facebook has been one the most highly anticipated IPOs in years. I'm here today with senior analyst, Rick Summer to see if now is a good time to dive in or if investors should wait for a better opportunity.

Rick, thanks for joining me.

Rick Summer: Sure thing.

Glaser: So let's get your first take on Facebook. When you dive into the company's financials, what do you see? What do you like about this company?

Summer: I think first and foremost, we can't forget how many users it has. There are north of 900 million monthly actives who are going to the site, and more than half of those are actually interacting in some way with Facebook on a daily basis. That level of engagement is absolutely tremendous.

Secondly, you have a wild level of profitability. You have almost 50% operating margins, and a meaningful $3.7 billion in revenue on trailing basis. This is a company certainly to be reckoned with and certainly a future force that already has a business model that's proven today.

Glaser: Let's take a look at the economic moat. It's the cornerstone of lot of Morningstar's equity research. What kind of competitive advantages do you think Facebook has, and will it be able to keep those up over time?

Summer: It's a great point, and this really underlies a lot of what we're doing and talking about with respect to Facebook and with respect to our valuation, as well. Facebook's moat is really built around its user base. So, it's actually 900 million users who are not only just going there, but they are interacting with it. It's part of their identity; it's part of how they communicate with their friends within their Facebook network.

That in and of itself is the most important compelling part of the moat, but it's not just a destination. We have people that are using authentication, meaning the login credentials for Facebook at other third-party websites. We have other third parties that are actually incorporating Facebook data, social plug-ins, comments, and lots of different things. You actually have Facebook spidering out into the fabric of the Web. Those are very difficult connections to be able to dislodge by a competitor.

Secondly, Facebook has actually monetized this and proven that it can generate excess returns on capital even in an environment where ad pricing is pretty weak, because we haven't really figured out yet how to advertise in social networks.

Glaser: So where does the moat come out then?

Summer: Right now, we have a wide moat. The only other wide moat company in the Internet space that we cover is Google, of course. And we're looking in the Internet advertising land of this being a two-headed monster going forward.

Glaser: It doesn't sound like Facebook is going to go the way of MySpace, Friendster, or other social networks that haven't done so well. But what kind of growth is in front of Facebook. It's seem like almost everyone already has a Facebook account. Will the company be able to grow users, or does it need to grow users in order to expand that top line?

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