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Facebook Expands Ad Network

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For the first time in its history, Facebook Inc. (FB) started distributing ads on other websites, a clear move toward building an online ad network. The social networking company recently started showing ads on social game developer Zynga’s (ZNGA) website.

Zynga players are required to use their Facebook accounts to enter Zynga.com. The ads will target the users who have already shared their details with Facebook. However, Facebook said that it will not share these details (of both users and advertisers) with Zynga.

The ads include sponsored stories and other formats that Facebook displays on its own website. The company said that the ads do not involve any “new targeting criteria” from advertisers and are similar to the ads shown on Facebook.com. Currently, the two companies have an ad revenue sharing agreement in place, signed in 2010.

Facebook earned 82.0% of its first quarter 2012 revenue from ads. However, slowing ad revenue growth coupled with lack of visibility around monetization of mobile platforms has been a concern lately.

Moreover, automobile maker General Motors (GM) decision to drop paid ads and questioning about the effectiveness of Facebook ads compared to Google’s (GOOG) AdSense further aggravated the situation.

In such a scenario, distribution of ads beyond Facebook.com will provide a much-needed impetus to Facebook’s monetization efforts in our view. Moreover, Zynga has a strong mobile user base, which will further improve Facebook’s monetization prospects.

We believe that Facebook will continue to distribute ads to third party websites, thereby building an ad network that is similar in concept to AdSense. Currently, Google is the leading provider of online ads and it will be difficult for Facebook to displace it in the near term.

Nevertheless, Facebook’s massive user base (around 900 million) and its ability to track personal details over time make it a formidable force in the online ad market. Facebook can use this massive database to help advertisers target relevant ads going forward.

Moreover, we believe that Facebook will continue to earn significant non-advertising revenues from third party developers and through the sale of Facebook Credits (a form of virtual currency) going forward.

We remain Neutral over the long term. Currently, Facebook has a Zacks #3 Rank, which implies a Neutral rating over the short term (1-3 months).

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