I am a self-directed investor who manages my own portfolio with the objective of achieving early retirement. I have a dividend portfolio, which is currently on track to deliver close to $28,000 in dividend income for 2014 and maximize income return. Additionally, I have a growth portfolio, which I am managing to maximize capital returns from established companies. Finally, I have a small venture portfolio, which has the focus of extracting more speculative capital returns from early-stage companies. I am considering Facebook (NASDAQ:FB) as a possible addition to my growth portfolio.
Facebook has been on a tear as far as revenue growth in recent months. The company generated $2.5B in ad revenue in Q1 2014, of which mobile ad revenue accounted for 59%. In spite of this already tremendous growth, ongoing shifts in the advertising market and new business initiatives suggest strong revenue growth will continue.
A platform for brands to leverage across devices
Interesting shifts appear to be occurring in the advertising market where large brands are increasingly looking to have more control of their ad buys and have more certainty over campaigns. Thus rather than contract out advertisement placement to ad agencies, the major brands are looking toward platform plays that can give them access to a specific known groups of users as opposed to a black box, where campaigns get executed with unknown publishers to a variety of end user groups.
It's here that Facebook is particularly strong as there are only a handful of platforms that have the global reach to a known set of users with specific attributes with the ability to have detailed campaigns run against such users.
Facebook also solves the "mobile cookie" problem for advertisers. This problem refers to the inability to link users' actions across multiple devices. With desktop usage, user interactions across different web properties can be tracked and monitored by virtue of code that can be embedded in a web page. Users can thus be served up relevant ads no matter which web property they visit. No such cookie exists on the mobile device, or tablet device. Thus advertisers face a glaring gap in being able to reach relevant users on mobile.
Facebook helps solve this problem for brands by virtue of the user login. Brands are able to get granular awareness of which users they are tapping into across which device. Thus, brands can buy a specific pool of users relevant to a given campaign and target these users across multiple devices. Importantly, they can do this with a single media buy, and see the results more effectively than if such a buy is spread across a number of different publishers and intermediate agencies.
Facebook Ad Exchange (FAN)
Facebook recently started a new business unit which facilitates mobile advertising on 3rd party publisher applications, in a manner similar to what Google (NASDAQ:GOOG) adsense does for publishers today. This new initiative will allow the management of advertising, payment routing and ad targeting on behalf of developers. Facebook Ad Exchange will see Facebook leveraging its considerable ad targeting expertise in a manner that hedges against potential declines in the usage on its own core service. More significantly, it adds to Facebook's intelligence about the behavior of users on properties outside of its own and gives feedback about what sorts of ad formats work well to which user groups. This is valuable intelligence that it can be used to boost its own ad targeting.
To give some sense for just how large this market could be, Google currently earns approximately $12B in revenue through adsense, via its cut of revenues on 3rd party websites. While the Facebook product is initially only mobile and targeted to app developers, there's no question the scope of this service could expand over time to other mobile publisher properties and beyond.
Facebook video ad units
Facebook has started experimenting with a new form of video ad unit, which early indications suggest is attracting high advertiser interest. The video ad unit is being offered at close to $1M per ad slot and currently is being offered on an invitation only basis. Initial estimates suggest that this new format could eventually contribute more than $1B plus in revenue to Facebook in the next 2-3 years.
Next Generation Drivers
The really intriguing aspect of where Facebook's business could go is hinted at by the recent purchases of WhatsApp and Oculus VR. Both suggest possible move by Facebook into the digital commerce.
While Facebook's WhatsApp purchase has gained a lot of press for the eye popping purchase price of $17B, what hasn't been discussed as much is how mobile messaging platforms are evolving into e-commerce portals to sell users a variety of socially discovered content. Facebook doesn't have to bombard WhatsApp users with a multitude of advertising to recoup a return on investment on its purchase (whether it wants to do so is another thing entirely). Intelligent leverage of the WhatsApp user base should open up avenues for revenue sharing on a variety of digital content including games, music, video and books. Direct and group messaging allows much more effective content sharing than passive posting and sharing on a Facebook page.
Facebook's purchase of WhatsApp allows it to be a hub of social discovery for all kinds of digital content in a way that positions it very favorably against Amazon (NASDAQ:AMZN). In fact, this highlights a weakness that Amazon faces as consumer buyer behavior becomes increasingly influenced by social behavior online.
For further evidence that mobile messaging platforms with large user bases can be transformed into mobile commerce engines, one doesn't have to look a lot further than messaging platforms like Line and KakaoTalk. Both generate several hundred millions in revenue from their messaging platforms through gaming revenue share, services to app developers and digital media. Also mobile communications platforms are becoming increasingly attractive to the large e-commerce behemoths. Alibaba recently lead a round of investment in mobile communications company Tango, investing some $215M of a $300M round of financing.
The Oculus Virtual Reality acquisition positions Facebook for the eventual transition that will occur away from messaging and direct communication that currently dominate social interactions. The declining wave of direct phone communications is already evident amongst younger groups, who are leaning towards messaging as their preferred means of communication. The Oculus acquisition is one potential bet that more immersive experiences could be the way that groups of people choose to interact in the future. In my view, Oculus represents a hedge with respect to where users may spend their time in the future as opposed to an expectation that virtual reality experiences are a near-term reality. Facebook needs to be wherever users are spending time to be able to serve up relevant advertising or merchandise to its user base.
Facebook has some strong growth drivers in its core business which will continue to propel revenue and earnings higher. Brand interest in having greater control over advertising spending and campaign targeting will see a continued shift away to platforms with direct access to specific user segments. New video unit formats are starting to see strong initial interest from advertisers, while Facebook's advertising network holds significant potential to be a real driver of future revenue. Finally recent acquisitions have the potential to position Facebook as a much stronger player in the digital commerce arena.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FB over 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.