- Facebook's WhatsApp acquisition might not be that unreasonable, with the potential for $5 billion in incremental revenue within the next decade.
- Facebook still has two other key revenue drivers that it'll pull in 2014, including video ad and Instgram monetization.
- Compared to its major tech peers, Facebook is still relatively cheap -- my price target is $85.
The WhatsApp acquisition by Facebook (NASDAQ:FB) has been well covered by analysts and the media alike. Many of which have a mixed feelings over the $19 billion price tag. Even so, the fact that mobile is proving to be very successful for the company, WhatsApp is a strategic addition.
Facebook's EBITDA runs around 55% to 60%, but the WhatsApp acquisition can boost this even higher, where the app generates EBITDA margins in excess of 80%. While the near-term monetization of WhatsApp won't be the focus, rather revenue growth, the SMS advertising market remains wide open. I look for Facebook to blaze a path here.
A quick reminder of Facebook's large market opportunity
Facebook is still at the forefront of key ad trends. One being there's an increase in online ad spending, compared to off-line spending, and the other the shift from desktop to mobile internet consumption. eMarketer pegs online ad revenues generating $170 billion by 2017, and up from $120 billion in 2013.
Yet, mobile ad spending is the real story. eMarketer has mobile ad revenue reaching $65 billion by 2017, compared to under $20 billion in 2013. The worldwide ad market is about $600 billion and Facebook is gaining traction here with all marketers, from brand marketers to developers. On the flip side, the SMS market is worth some $120 billion worldwide.
As we saw in its fourth quarter, Facebook is hitting on all cylinders with respect to monetization and user engagement. The WhatsApp acquisition gives Facebook a presence in the wide open SMS market and gives it an entirely new revenue avenue.
The monetization for WhatsApp can seem like somewhat of a crap shoot. However, I don't see it that hard, as the opportunity is quite impressive. The current user base is just under 500 million, but can easily hit nearly 2.4 billion in the next ten years. Granted the percentage of users paying is less than 20% now, I'd expect that with the help of Facebook that number could get to 70%.
And with average revenue per paying user going from $1 currently to a modest $3, the incremental revenue opportunity for Facebook in ten-years time is nearly $5 billion. Meaning, WhatsApp went for 4x sales in ten-years' time. Even in just a few short years, to 2016, I'd expect WhatsApp can close to triple its user base to 1.2 billion and generate nearly $700 million in revenue. That would mean Facebook bought WhatsApp for roughly 27x revenues in 2016. Putting this in perspective, Twitter trades at nearly 27x sales.
All in all, the valuation for Facebook is still very compelling. Shares are trading at a 20x enterprise value-to-EBITDA multiple based on 2015 expectations. This puts Facebook's valuation at a hefty discount from a relative standpoint. Other "high flying" momentum stocks trade well above this. There's Netflix (NASDAQ:NFLX) trading at 29x forward EV/EBITDA, Pandora (NYSE:P) at 66x, Zynga (NASDAQ:ZNGA) 22x, LinkedIn (NYSE:LNKD) 32x, Yelp (NYSE:YELP) 57x and Twitter (NYSE:TWTR) 76x.
Assuming that a justified multiple for Facebook is 20x forward EV/EBITDA, and using 2016 EBITDA estimates of $10.1 billion, the upside to the stock is over $85. The growth story is still there for Facebook, which includes ad monetization via video and Instagram, and the addition WhatsApp, which means there's still a number of years of market beating returns ahead for Facebook investors.