When Facebook (NASDAQ:FB) had its IPO a couple of years ago, there was a big fuss over just how the social network was going to grow into its valuation. This included being able to grow revenues. After turning 10 years old earlier this year, Facebook finally appears to be onto something meaningful.
The tech giant appears to have a solid strategy for generating revenue from its users; the first of which is video ads, the second is ads on Instagram. The other real beauty is that these avenues appear to already be paying off for stockholders. Its positive fourth quarter report drove the stock up nearly 20%, adding confirmation that those strategies are already working, and that Facebook has impressive monetary potential.
Facebook users and visits continue to soar
Starting out as an exclusive social networking platform for Harvard University students, Facebook moved from just a network for students to include just about anyone in every corner of the World. With 1.22 billion monthly active users, Facebook has become a truly international phenomenon over the last ten years.
Over the last year, the number of new users increased by 16%, which was driven primarily by international adoption. For many users, Facebook has become an integral part of daily life. Just look at the increase in mobile and daily usage. Over 900 million of its monthly active users are using it on a mobile device, which is 39% higher than last year. As mobile usage has increased, so has the growth in daily active users.
What growth of active users means
Because Facebook's primary source of revenue is advertising, growth in the number of active users, especially daily active users, directly translates into dollars for the company. With total advertising revenue at $2.1 billion, an increase of 58% over last year, Facebook still has room to grow. Right now Facebook generates only $2 in ad revenue per user in comparison to Google at $8. By improving the ability to generate revenue per user, Facebook is looking at tremendous potential.
According to fourth quarter results, mobile advertising was the key driver of revenue. With more than 50% of ad revenue coming from mobile ads, the increase in the number of mobile users will drive future growth. Members who use Facebook on their mobile device are more engaged and therefore create more opportunities for advertisers. Facebook is constantly improving its app to create a better user experience and to continue the growth of mobile users.
The first major revenue driver will be video ads
Facebook has been changing the way ads are presented to users to increase the ad revenue. The company supplemented ads on the sides with ads within the newsfeed to increase visibility. In the last quarter, the company introduced video ads to entice more users to click on the ad.
As more content is viewed and absorbed through video, viewers are more likely to view and respond to video ads, than message ads. Introduction of auto-play videos that play as user is scrolling through the newsfeed are going to grab attention of those who are already desensitized to message ads.
With mobile devices usage increasing, especially during "prime time," Facebook is trying to tap into the budget that advertisers earmark for prime-time television. We know that today people watch TV more interactively; they use Facebook to comment on TV content and communicate their opinions with friends while watching. This presents a perfect opportunity for Facebook to generate additional money.
The most recent comScore data shows that the Facebook has seen a near 80% jump in content video minutes viewed for January on a month over month basis. This comes as the entire U.S. saw a 3% decline in content video minutes. This suggests that Facebook is having success with video, suggesting that video ads will be a big part of its growth going forward.
The second key (and most important) revenue line will be ads on Instagram
Since the Instagram acquisition, Facebook has been committed to growing the app, a platform to share pictures. The company has been known to continuously improve features of the app to continue growing its user base. With a base of over 180 million users, Instagram is the next big revenue opportunity for Facebook.
As of October 2013, Facebook created a way to monetize the strong user base by introduced ads. Even though the revenue from Instagram is not separated out, we can assume that increased revenue for the quarter was partially attributed to Instagram. If Instagram can achieve Facebook average revenue per user, currently at $2, the company is looking at additional $360 million - an incremental 5% on its current revenue base.
But will aggressive ads drive users away?
Many have doubted the strategy of more aggressive ads, citing that it would reduce the number of users, but the numbers show a different story. Engagement continued to remain strong in the fourth quarter, when video ads were introduced. Engagement was at 61.8% in comparison to 61.3% in 4Q 2012. Suggesting that more aggressive ads has yet to have a negative impact on user growth.
Facebook is constantly working on making ads more relevant and timely, making ads less of an annoyance, and more of a distribution of pertinent content that users are interested in. This would of course translate into happier ad companies and therefore more revenue for Facebook.
The WhatsApp mayhem
I'd be remiss if I didn't mention Facebook's recent WhatsApp acquisition, which can also be a growth driver. The price tag was a bit of a shock for many investors. Yet, in the context of its 450 million monthly active users and 70% engagement rate, above Facebook's (closer 60%), the move should be advantageous to Facebook longer-term despite the purchase price. Meanwhile, Facebook also only paid around $40 per monthly active user for WhatsApp, versus its own MAU valuation of $140/user. The move just further reiterates Facebook's focus on mobile.
Fourth quarter results show that Facebook is on the right track. The results suggest that Facebook's improvements in generating revenue are working. This means that if Facebook continues to implement these strategies, it has an opportunity for significant revenue that will pay off big for stockholders. It is important to note that despite the fact that Facebook is a decade old, it is just now beginning to fully monetize its users, which means it is still a high growth story. This was obvious as after the quarter results, analysts hurried to upgrade the stock to reflect the real future value of the company. We still think there's money to be made for Facebook in the next few years, meaning there's money to be made for investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.