Is Oculus The Future Of Facebook?

Apr. 1.14 | About: Facebook (FB)


On March 25th, Facebook announced it was acquiring Oculus VR for $2 billion.

Backlash from the gaming community and announcements from Facebook CEO Mark Zuckerberg suggest Oculus will diverge from its gaming roots into other areas.

Oculus provides Facebook with the opportunity to build a presence in virtual reality, and gain control of the hardware its software will run on, providing more lucrative opportunities for advertising.

Facebook OculusClick to enlarge

Source: Creative Commons

On March 25 Facebook (NASDAQ:FB) announced it was acquiring Oculus VR; the virtual-reality company behind the Oculus Rift for $2 billion. In a deal worth $1.6 billion in stock and $400 million in cash, Facebook will take control of the innovative company. The announcement comes little over a month after Facebook announced it would be acquiring WhatsApp for $19 billion, and has left many investors and analysts wondering what Facebook plans to do with Oculus.

Oculus VR has found success with its Rift gaming headset; selling 60,000 units of the development kit (not the actual consumer version) and having to stop production of the first version because demand was too high for production capacity (as well as certain components being used that were no longer manufactured).

This March, Oculus announced the Rift Development Kit 2, featuring a new OLED screen, a camera developed from the ground up by Oculus to track head movement during use, and other feature updates. Despite cosmetic differences, Palmer Luckey, the founder of Oculus VR said the Development Kit 2 was different in "no meaningful way," although sales of the DK2 are expected to be higher as it nears consumer readiness and more games are released that are compatible with it.

More interesting in the story of Oculus was its acquisition by Facebook, a company that, until recently, has been involved in the gaming industry merely as a platform for game publishers like Zynga (NASDAQ:ZNGA) to publish games.

When Facebook announced it had agreed to acquire Oculus, there was swift backlash from the gaming community that up to now, has been the nearly exclusive focus of Oculus. Large game developers like Notch, the Swedish developer behind the multi-million copy selling Minecraft, pulled their support for Rift, with criticism centering around privacy concerns over Facebook.

Facebook's acquisition and the backlash from the gaming community could signal a turning point in the future of Oculus VR. Mark Zuckerberg said of the newly acquired Oculus: "[it] has the chance to create the most social platform ever, and change the way we work, play and communicate."

Up to now, virtual reality has largely been a gimmick used for gaming and simulators like Nintendo's (OTCPK:NTDOY) failed Virtual Boy system that was discontinued a year after launch. Many consumers remain skeptical of virtual reality, but technology that has come available in recent years, from video conferencing to the head and eye tracking used in the Oculus Rift could make Oculus the communication platform of the future, connecting billions of people in a way that has only been allowed through the kind of technologies previously mentioned.

Interactive video conferencing and learning in virtual classrooms were just the start of what Mark Zuckerberg thought possible for the future of Oculus - and Facebook.

Facebook's acquisition of Oculus works for both companies. Oculus needs Facebook's massive user base, infrastructure, and backing to build the services on its devices that could truly turn it into the device of the future, and Facebook could benefit as the owner of the future of communication. If the Rift were to used as a communication device, the data provided on users could be highly valuable, and advertisements could be served onto certain devices based on the topics users are discussing through video conferencing and more. The issue of advertising at this point in Oculus VR's development would be a highly sensitive one, and Facebook would be unwise to introduce ads into the core video gaming features at this time, while the Oculus continues to make the bulk of its sales from hardcore gaming enthusiasts.

The Oculus Rift Development Kit 2 prototype

Above: The Oculus Rift Development Kit 2 prototype

Source: Oculus VR

Oculus VR has already announced its next development kit (the DK2), and it's expected to sell more units than its predecessor, with more games ready for the system and enhanced features for better visuals and a more immersive experience. Despite sales prospects looking well for a development stage unit, if Oculus is going to develop the kind of technology to allow for the goals Mark Zuckerberg has described, Facebook's capital can finance research while the company is still young.

At the heart of the Facebook deal is that Facebook paid $2 billion for Oculus, $1.4 billion of which is in shares of Facebook at their highest price since the company's IPO in early 2012. While $2 billion is a large deal for a company that has been around for 2 years, it represents little more than 1% of Facebook's market value, despite a 10% decline in its share price over the past 3 weeks. While the acquisition is a highly risky one, and one that diverges from Facebook's core social media and communication business, it offers the company the opportunity to become a pioneer in a technology that has yet to be widely used, as well as to use its funds and position in the market to help Oculus become the next big technology that changes how we communicate.

For Facebook's investors, the Oculus deal is more significant in what it means for the way that Facebook believes it will build its business in the future, as it faces slowing and even declining user growth in many North American demographics. With declining user growth, it has become even more important for Facebook to build its moat, keeping users interested, and wanting to use their services. Like Google (NASDAQ:GOOG), Facebook has been building a wide variety of services that almost all internet and smartphone users use in their daily lives, from WhatsApp to Instagram, all while continuing to build on the core Facebook service that still provides the large majority of its current revenue.

For Facebook to succeed at becoming the Google of communication, it will have to integrate its current services more closely. Nearly two years after acquiring Instagram, Facebook has yet to tie in the service in a way that provides a real incentive for the young user base (a demographic that Facebook has been losing on its core service). Despite the potential for Oculus and Facebook's other recent acquisitions, until it has been seen that Facebook can successfully tie in services like Oculus into its main brand to grow its revenue and value proposition for users to stay with Facebook, investors should remain wary of the issues Facebook has been facing with market saturation in its most valuable markets and slowing user activity.

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.