Facebook Flexes Mobile Muscle in Solid 2Q

 Facebook (FB) posted second-quarter results showing accelerating revenue growth from advertising, a surprise in the face of the slowdown from industry giants such as  Google (GOOG) and  Yahoo . In our view, this performance is notable, particularly as users continue shifting their Internet usage from desktops to mobile devices. We believe this strength highlights Facebook's unique assets as advertisers are spending money with the social-networking company over other programmatic alternatives like Google's DoubleClick network or Yahoo. After updating our model, we are leaving our fair value estimate and Morningstar Economic Moat Rating unchanged.

Facebook's ability to turn traffic (both mobile and Web) into revenue continues to improve. Total company revenue grew 53% versus 2012, while revenue from advertising (88% of company revenue) increased 61%, the fastest annual rate in the past seven quarters. Performance in the mobile segment continues to impress us, as revenue grew approximately 75% sequentially, reaching 41% of the company's advertising segment. According to our analysis, revenue per mobile user increased 60% sequentially, as advertisers pay up for products such as the mobile news feed and mobile app install. The gap between mobile and desktop ads is converging rapidly. By contrast, the mobile segment has been a short-term overhang on Google's growth. Facebook's differentiated customer data are critical to this performance, in our view.

Importantly, engagement trends continue to improve, as 61% of the company's 1.15 billion users access Facebook services on a daily basis, versus 58% in the prior year. Monthly average users grew 21%, and daily average users grew 27% versus 2012. Although media reports continue to anecdotally refer to "Facebook fatigue," the company's engagement trends are encouraging. Additionally, CEO Mark Zuckerberg noted internal company data showing that overall engagement trends among its teen segment are not changing materially, though he did not share any specific data.

Our long-term optimism depends on the company's ability to leverage its unique customer data outside the walls of its Facebook Web applications. Our forecast assumes revenue increases at a 30% compound annual rate during the next five years while operating margins expand to the low 30s. We believe the success of Facebook's platform strategy will be the ultimate determinant of its growth potential. Importantly, the company continues to spend capital in the appropriate areas, in our view, as management spoke to investments in developer tools and advertising technology as key bets for the future.

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