Facebook Profit Jumps 71% -- 2nd Update

By Deepa Seetharaman Features Dow Jones Newswires

Facebook Inc.'s news feed is running out of room for advertisements, but the social media giant is making up for it with higher prices and new slots for ads in videos and its messaging apps.

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The company on Wednesday said profit spiked 71% in the second quarter. While growth is still rapid, Facebook warned that the number of ads in the news feed -- its primary source of revenue -- is hitting a ceiling.

Facebook and Google revamped advertising by making digital the dominant platform over the past decade. Google, part of Alphabet Inc., and Facebook together accounted for 99% of the online ad industry's growth last year, according to Pivotal Research. But now both tech giants are trying to figure out the next generation of online advertising.

Google said earlier this week that it is serving up more ads on smartphones and on YouTube, its video platform. While the newer ad formats drove a 52% surge in the number of clicks, they are less lucrative than search ads, Google's legacy business.

Facebook, meanwhile, is looking beyond the highly profitable news feed to the rising consumption of video and its two chat apps, Messenger and WhatsApp, for growth.

Chief Executive Mark Zuckerberg predicted video would become the largest driver of Facebook's business over the next two to three years, while messaging could yield dividends within five years. He added that artificial intelligence could help advertisers figure out which audiences to target on Facebook.

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That shift isn't without risk to Facebook. These emerging ad formats don't earn Facebook as much money as ones shown in its news feed, executives said. They also need to build new types of ads that can work outside the standard stream of posts that make up Facebook's news feed and its photo-sharing app Instagram, which together drive nearly all of the company's revenue.

"There are real questions there that we need to manage well," Mr. Zuckerberg said, of the company's embrace of video as a future source of ad revenue. Facebook recently started testing mid-roll ads, which appear at some point during a video on the social network.

Mr. Zuckerberg also showed newfound urgency to cash in on messaging. WhatsApp, he said, is now used by 1 billion people a day. This month, Facebook introduced ads on Messenger, a rollout that will inform how Facebook monetizes WhatsApp, executives said.

"I want to see us move a little faster here, but I'm confident that we're going to get this right over the long term," he said during a conference call with analysts.

Facebook's stock was 3.7% higher in after-hours trading, building on a 44% increase since the beginning of the year.

In the second quarter, net income totaled $3.9 billion, surpassing its larger rival Alphabet, whose bottom line was hit by a fine from European regulators. Revenue jumped 45% to $9.3 billion, boosted by a 24% increase in Facebook's average ad price, executives said during the call.

Showing too many ads could turn off the more than two billion people who check Facebook at least once a month. Today, one of every seven to 10 posts is an ad in Facebook's news feed, said Jan Dawson, senior analyst with Jackdaw Research.

The company is buying original video programming -- some shows as long as 30 minutes an episode -- that could in turn offer opportunities for advertising as part of Mr. Zuckerberg's broader desire to transform Facebook into a "video-first" company. "Video is part of what's going to expand the inventory of ads on Facebook," Mr. Dawson said. "A half an hour of video is potential for more ads."

The mid-roll video ads Facebook has been testing have lower margins than news feed ads, executives said on the call. Facebook shares a portion of the ad revenue with the creator in this model.

The success of ad breaks "will depend both on the ad breaks and on the content," Chief Operating Officer Sheryl Sandberg said in an interview. Many advertisers are still repurposing television ads to use on Facebook.

The television ads "do not work as well as ads that are natively mobile, " Ms. Sandberg told analysts Wednesday. Ads that are developed for mobile, Facebook's primary format, are shorter and the brand is mentioned faster than in TV spots, she said. She compared the strategy to the early days of TV ads when people read ads in front of a microphone on screen.

Write to Deepa Seetharaman at Deepa.Seetharaman@wsj.com

(END) Dow Jones Newswires

July 26, 2017 20:54 ET (00:54 GMT)