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Facebook Shows Why It's a Giant in the Mobile Space

The social-networking firm's second-quarter ad revenue soared, particularly in the mobile business, but despite Facebook's upward potential, shares are slightly overvalued at current prices.

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 Facebook's (FB) solid second-quarter performance surpassed our expectations for both revenue and profitability, as advertisers continue to increase spending across all geographies. After adjusting our valuation model, we anticipate increasing our fair value estimate by more than 10%, though we consider the shares modestly overvalued at these levels. Even though we see no catalyst for selling the shares, we are hesitant to recommend allocating new money toward an investment in Facebook. Our wide economic moat rating is unchanged.

Although we expect revenue growth to eventually fade, near-term results continue to outperform. Total quarterly revenue increased 61%, led by the advertising segment which grew 67%. Perhaps most importantly, mobile revenue rose 151% over the year-earlier figure. Without question, this company is a current mobile advertising giant, posting approximately $1.8 billion in mobile revenue for the quarter. 

In terms of profitability, the leverage in Facebook's business model is evident. GAAP operating margins came in at 48%, above our long-term expectations. We expect Facebook to eventually--and prudently--invest in projects that are lower-margin but that ultimately provide value to both advertisers and shareholders over the long term. We continue to model a decline in profitability over time. That said, we believe the shares today are valued at the long-term potential for the company to achieve and hold on to its position as a leading digital advertiser.

We expect Facebook to continue making considerable investments in the mobile arena, as we believe the company lacks some of the compelling assets that  Google (GOOG) (GOOGL) and  Apple (AAPL) have in the context of Morningstar's Smartphone Value Stack. For example, Google and Apple are leaders in helping developers launch applications, charge subscribers, accept payments, and analyze their customer behavior. Still, as the most heavily trafficked mobile application (reported as 20% of time spent), Facebook is immediately relevant to mobile advertisers, and its acquisition and development strategy has been sound, in our view.

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Rick Summer does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.