Facebook Inc (NASDAQ:FB) is hoping to sell online video ads soon. This will help the company earn more revenue and sell a more exclusive product. It is important to note that a recent survey found that 41% of ad buyers are expecting to move money from the traditional display ads that Facebook thrives on to video ads. The move to online video ads cannibalizes its traditional ads while running the risk of driving users away from an overly commercialized Facebook experience.
The world’s biggest social network is stuck between a rock and a hard place. Mark Zuckerberg tried to keep the company private as long as possible, until he accumulated many investors and had to go public. With a current price to earnings ratio (P/E) around 170, he is under a great amount of pressure to increase Facebook Inc (NASDAQ:FB)’s earnings and revenue to justify its high valuation.
Watch Revenue Growth
Advertising revenue in the recent quarter increased 53%, largely by placing ads directly in front of users’ eye in the news feed. There is only so much growth that the company can squeeze from placing more ads directly in the news feed.
Now, Facebook Inc (NASDAQ:FB) is forced to look for other growth avenues. As the majority of recent user growth comes from less developed countries like Brazil and India, online video is one of the company’s best bets.
Take Search Ambitions With a Grain of Salt
Facebook Inc (NASDAQ:FB) is fond of the idea that it will move onto conquer the search market and destroy Google Inc (NASDAQ:GOOG). The problem is that Microsoft Corporation (NASDAQ:MSFT)’s Bing is already tightly integrated with Facebook, and yet Google is holding its market share. An even greater issue is that even with Facebook’s help, Microsoft’s online services division continues to lose money.
Recently Bing reached a 17.9% U.S. market share, and yet it still posted an operating income loss of $-372 million. It is important to note that a large portion of Bing’s growth comes from former Yahoo users. Given that Yahoo! only had 11.4% of the market as of June, 2013, there is a limited amount of growth left in this strategy.
With a profit margin of 28.1% and a return on investment (ROI) of 18.5%, Microsoft Corporation (NASDAQ:MSFT) can easily use its other products to pay for Bing’s losses. Facebook Inc (NASDAQ:FB)’s slimmer profit margin of 9.1% and recent quarterly net income of $333 million mean that it would be prohibitively expensive for Facebook to break ties with Bing and make its own traditional search engine.
Online Video Ads Will Help Google
The use of video is expected to grow, and Google Inc (NASDAQ:GOOG) is a strong player in the market with YouTube. Google will lose some income from its third party ad network as marketers switch from display ads to video ads, but Google will receive an income boost in the process. For third party content hosted on YouTube it is reported that Google takes a 50% split, as opposed to the 30% split Google commonly makes on its AdSense network.
Google Inc (NASDAQ:GOOG) already enjoys a strong profit margin of 21% and an earnings before interest and taxes margin (EBIT) of 24.3%. With clean balance sheet and a total debt to equity ratio of 0.06, the company is very financially attractive.
Conclusion
From an Advertiser’s perspective, Facebook Inc (NASDAQ:FB)’s display and video ads can be replicated on other major web properties. The company is the world’s leading social network, but it is far from having a control on the global display ad market or video ad market. Google Inc (NASDAQ:GOOG) is in a different position. Outside of China and Russia it maintains very tight control on the search market.
Microsoft Corporation (NASDAQ:MSFT) and Facebook Inc (NASDAQ:FB) are fighting together to break Google Inc (NASDAQ:GOOG)’s control, but it is far from certain if they will ever be able to reach their goal. Until things change, Google’s tight control of the search market and P/E ratio below 30 make it one of the more attractive technology firms.
The article Don’t Overestimate Facebook’s New Video Ads originally appeared on Fool.com and is written by Joshua Bondy.
Joshua Bondy has no position in any stocks mentioned. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of Facebook, Google, and Microsoft. Joshua is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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