Facebook‘s (NASDAQ:FB) shares have risen by roughly 30% in 2014 alone, further dispelling investor concerns that had plagued the stock in 2012. The growing digital advertising market, the increasing share of mobile in the mix, the attractive return on investment for businesses advertising on Facebook, and the company’s investments in optimizing its ad strategy are some of the factors that have fueled its increased valuation. That said, Facebook includes the risk of being priced too high as the current market multiples suggest. In this analysis, we focus on broad factors that are driving the company’s stock and will follow up with another note discussing key risks that investors need to be aware of.
Our current price estimate for the company stands at $45, implying a discount of about 35% to the market price.
Growing Digital Advertising Market
The digital advertising market is growing globally, and has already reached roughly 24.5% of total media ad spending in the U.S.  According to a report published by research firm eMarketer, overall media ad spending in the U.S. stood at an estimated $158 billion in 2011 and is expected to reach $197 billion by 2017, growing at an annual rate of roughly 3%-4%. In contrast, the digital ad market is expected to grow in double digits. A significant portion of this growth will come from mobile where Facebook has a strong presence. According to a December 2013 report, mobile platform accounted for roughly 22% of U.S. digital ad spending in 2013 compared to less than 3% in 2010. Internet companies such as Facebook, Pandora (NYSE:P), Google (NASDAQ:GOOG), Twitter (NYSE:TWTR) and LinkedIn (NYSE:LNKD) have ramped up their mobile ad businesses significantly in the last year and a half.
Facebook’s Growing Market Share
While Google has long dominated the digital advertising market, Facebook is emerging as a new key player and has played a vital role in the overall industry growth. Facebook’s share in total U.S. digital ad revenues stood at 5.9% in 2012. This figure jumped to an estimated 7.4% in 2013 and is further expected to reach 9% in the next two years. There is no doubt that Facebook has mastered the art of mobile advertising by making its ads a natural part of the content feed. The return on investment (ROI) for marketers has been very high on Facebook as compared to other platforms, and the company has successfully attracted millions of small businesses to market themselves on its platform. More than 25 million small businesses advertise on Facebook now. As a result, the company has registered a massive increase in its average ad pricing in recent quarters. In Q4 2013, the figure demonstrated year-over-year growth of 92%. These factors will continue to drive Facebook’s share of the overall digital advertising market.
Possible Symbolic Effect Of WhatsApp Purchase
When Facebook announced WhatsApp’s acquisition, it appeared that the company bought a potential competitor, and in the process rectified its failure in the mobile messaging market. Its Facebook Messenger service hasn’t garnered much attention and WhatsApp, by far, is one of the most popular and fastest growing messaging apps in the world. In addition, there are young users who use WhatsApp but not Facebook. This offers the company an opportunity to further consolidate its position globally and monetize this untapped user base. We also believe that mobile messaging is here to stay, even though the growth in the social networking industry might slow down. This is because mobile messaging enables a very basic human need — the desire to communicate with friends day-to-day in a convenient manner. In some ways, Facebook may have acknowledged a weakness in its business as it looks into the future, and is attempting to plug that gap through the acquisition of WhatsApp. The market may have rewarded this to a certain extent.
Disclosure: No positions.