Facebook earnings: Two huge hurdles remain

(MoneyWatch) When Facebook (FB) reported its third quarter results yesterday, the market reacted with wild enthusiasm. Shares soared 25 percent higher -- the largest one-day jump since the stock began its post-IPO slide -- even though the company lost money last quarter. One reason for the investor love was a 32 percent year-over-year increase in revenue and a 26 percent boost in monthly active users.

More importantly, news that 14 percent of the company's revenue comes from mobile seemed to contradict concerns about the negative impact that smartphone and tablet apps could have on Facebook's ad sales. It was warnings about a lack of revenue from mobile that started the stock's initial tumble. However, Wall Street should take another look at some details in Facebook's numbers, because they offer good reasons to remain cautious about the company's future.

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There is no doubt that Facebook is massively popular. But one problem the company has faced since its launch is how to make more money from every user. According to the pre-IPO filings with the SEC, average revenue per user was $5.11 in 2011, or roughly $1.28 per quarter. ARPU has been the big limitation on the company's financial growth.

Lagging on dollars per user

In the third quarter, Facebook had 1.01 billion users and $1.26 billion in revenue. That works out to just under $1.25 per user -- not quite $5 a year. In the same quarter last year, there were 802 million monthly average users and $954 million in revenue, or about $1.19 per quarter.

That's a 5 percent year-over-year growth in ARUP for the quarter, which is an improvement. But it still leaves the company far behind Google (GOOG) and even trails Yahoo (YHOO), which managed $3.97 per user last quarter (274 million users a month and $1.089 billion in revenue). Even if Facebook saw 14 percent of its revenue from mobile, adding more users doesn't build revenue per user fast enough to justify the company's market valuation.

The other problem the numbers suggest is the cost of running Facebook. Third quarter expenses were up 64 percent year over year. Even if you factor out stock-based compensation and the related payroll tax expenses that Facebook took on (and which Henry Blodget at Business Insider correctly argued was a backdoor $2 billion stock repurchase), the increase was still 57 percent.

The table below shows how third quarter expenses have grown between 2011 and 2012:

The R&D increase you could argue is a short term ramp-up to create better mobile apps and new features. Or it could be the cost of stock shares, many of which go to developers. Either of those would be temporary. Similarly, the general and administrative jump could be increasing infrastructure to handle a bigger company, but that expansion wouldn't necessarily go on forever.

Cost of getting those users

The other categories are more disturbing. Cost of revenue means that Facebook has to give up more to get the revenue it wants. If that is a trend, it would mean lower profits going forward.

The marketing and sales increase would seem to indicate that continuing to bring in more users is becoming increasingly difficult and expensive. At the more than 1 billion monthly users it claims, Facebook would be close to a 50 percent global market penetration. The days of picking the low hanging fruit are over.

But because Facebook depends on user growth far more than growth of ARPU to increase revenue, it must keeping expanding to the degree it can. That is likely to get more expensive, not less.

Investors who are reconsidering Facebook as a good place to put their money should keep the revenue per user and rising expenses in mind. Some encouraging mobile news doesn't eradicate these problems.