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Summary

  • Facebook after the acquisitions of WhatsApp and Instagram, now has 3 successful products in its portfolio;
  • I expect Facebook to continue its policy of strategic acquisitions not only to prevent a possible market share loss but also to increase its revenue and earnings growth;
  • Although the market is questioning the Mark’s strategic decision making capabilities because of the price at which the acquisitions are being made right now;
  • I believe these acquisitions would prove themselves worthy by increasing both revenues and user base.

In this internet/social media era it is hard to imagine anyone with no online presence. Facebook (FB) being the largest social platform boasts the biggest subscribers' base in the social media world. The company has a huge database of knowledge, which is second only to Google (GOOG) (NASDAQ:GOOGL). The company is also a major beneficiary of the major internet trends, including increasing usage of mobile phones, growth in video advertisements, and growing numbers of internet/tech-savvy generation.

Despite of the concerns that were highlighted soon after its IPO, Facebook has successfully made a transition away from desktop to mobile. Mobile ad revenues now represent 60% of the total company. Facebook has transformed itself into a market leading mobile company and should continue to attract advertising dollars into its platform.

A Platform Only Google Can Rival

The Menlo Park, California based company's has shown impressive user growth over the years. Facebook had 1.3 billion monthly users at the end of last quarter. The company has been continuously increasing its engagement and there has been a steady increase in daily/monthly active users ratio, which highlights the increasing importance of Facebook in the daily lives of its users.

U.S. and Canada are FB's most lucrative markets. In the first quarter, the U.S. and Canadian users generated average revenue of $5.16 per user vs. the $0.68 per user revenue generated by the rest of the world. However the company is rapidly spreading its presence abroad and by pivoting its strategy to cater to individual markets, the company I believe will continue to exceed analyst expectation.

Facebook's was able to increase its revenues by a staggering 57% year-over-year (Y/Y) in the last quarter. Mobile revenues have been the real strength of the company. Mobile revenues, which were almost zero in Q1'12, now account for more than 50% of the advertising revenues (Q1 '14). Facebook has transformed itself into a market-leading mobile company and should continue to generate significant revenue from advertisement.

As I mentioned earlier, the company has built a database of knowledge that few other than Google can rival. Going forward, as the identification and personalization gain more importance among the advertisers, FB will continue to provide the advertisers with a targeted audience and also at a scale that the advertising companies desire. Moreover, there is almost no other platform except Google, which has the scale where advertisers can target specifically and reach a very broad audience.

An Army of Brands

There has been a lot of talk around Facebook's multi-app strategy, which is meant to adapt Facebook to the way people use mobile phones. This is nothing new; Google has successfully adapted this strategy. Apps such as YouTube and Maps continue to be a success side by side with the core Google product. LinkedIn (LNKD) most recently went down the same path. LinkedIn, which purchased Pulse for $90 million last year, continues to integrate the app into its core offering.

Zuckerberg believes that multi-app strategy is meant to adapt Facebook to the way people use mobile phones and in mobile, there's a big premium on creating single-purpose, first-class experiences. The company is systematically developing brands that can live outside of the core.

In a recently published report, Barclays Analyst Paul Vogel made an interesting comparison between Disney (DIS) and Facebook. Although both Facebook and Disney have entirely different models, Vogel argues that Facebook in its efforts to build out a brand offering is heading down a similar path as Disney. And if you think about it, he makes a valid point. If you go back 10 years, Disney wasn't the company it is today and it was often criticized for lack of age diversity.

Disney was criticized for being too reliant on the young kids and not offering enough products to attract older kids to bridge them to adults. Over the years, Disney has bought and built brands that helped the company diversify and grow its business without losing its core. The young kids are still attracted to Disney, but the company has also built or bought new brands such as ESPN, Marvel, Pixar to cater just about everyone.

Facebook is heading down the same path. The company is building in house products and acquiring new brands, such as LiveRail, WhatsApp, Instagram, Paper, Slingshot, that will not only complement its existing core but will also extend its reach to different types of consumers and new markets. The company is building an army of brands that is attractive to different type of users. While the strategy doesn't drive users away from the core Facebook, it does create unique offerings for different users with different preferences.

Facebook has a huge targeting and advertising potential if it can create a unified approach to its different offerings, and I believe it can. For now Facebook, the core-product is the major source of revenue while the new offerings are not expected to generate money for some time. Overtime FB through a unified login can to create a link between its offerings, which could be a significant boost to targeting. The new anonymous login can play a huge part here, as it will protect users' privacy and control over what they want to share while offering a unified login across multiple offerings.

Instagram

Facebook acquired the mobile photo sharing app for $1 billion in stock and cash in April, 2012. Instagram user base is increasing rapidly since it was founded in late 2010 and was named "App of the year" by Apple (NASDAQ:AAPL) in 2011. Instagram currently has a user base of over 200 million users, and users are expected to increase significantly over the coming years.

Instagram isn't generating much money yet, as monetization efforts have just started but it has a huge potential to be a significant driver of advertising for Facebook. While much will depend on the eventual ad load and mix of static vs. video ads, if Instagram could generate even half of average revenue per user what Facebook currently generate that would be a huge boost to revenues (Barclays estimate, with 150 million user base, Instagram could generate $900 million to $1.2 billion in advertising revenue over the next few years). Facebook generated ARPU of $6.03 in the U.S. and $2.61, $0.95 and $0.84 for Europe, Asia, and rest of the world respectively in the last quarter of 2013. At the current pace, Instagram user base could grow to more than 250 million users by the end of 250. That means more than $2.0 billion in revenues from Instagram alone in the long run.

Another advantage that Instagram has is its younger demographic, a group that advertisers and marketers like to target. According to a research more than 90% of the Instagram users are below the age of 35. Moreover, approx. 33% of all the people in the age bracket 14-34 use Instagram and more than 40% of the teenagers in the 13-17 age bracket use Instagram. Instagram's user base is also more skewed towards women, 68% of Instagram users are female. Early trends have shown that Instagram video attracts more engagement than its competitor, Vine.

WhatsApp

The social media giant acquired the rapidly growing cross platform mobile messaging company earlier this year for $19 billion. WhatsApp boosts a significant 450 million subscribers with more than 70% of these users active on a given day. The company is showing a continuous strong growth and is currently adding more than 1 million new users every day. Moreover, WhatsApp messaging volume is rapidly approaching that of the entire global telecom SMS volumes. WhatsApp like Facebook has the ability of creating a habitual behavior which would keep the users intact. I believe WhatsApp is just another venture for the company to diversify itself and grow multiple brands simultaneously to stay relevant in the long run.

While analysts so far have been unable to answer the all-important question, what made Zuckerberg pay $19 billion for WhatsApp? After all only a small proportion of its users currently pay to use WhatsApp and it doesn't generate any revenue from advertising yet. All sort of things have been said and written about it, with some blaming Zuckerberg for being caught in the social media hype. However, I do not believe someone like Zuckerberg who is heavily invested in Facebook would throw away $19 billion just for the hype. He sees potential in WhatsApp, which the market hasn't been able to realize yet.

The combination of Facebook and WhatsApp will help the company accelerate growth and user engagement across both platforms. As GS analyst report in its report at the time, WhatsApp is just another step in FB's efforts to build out is application microcosm, which will help drive increased engagement and share of time spent as WhatsApp serves as a separate mobile app, enables fast mobile-to-mobile communication, and has a strong international footprint.

LiveRail

In its most recent acquisition, Facebook announced that it will acquire Live-Rail, an ad-tech company which focuses on serving right video ads to right people. LiveRail customers currently include the likes of Major League Baseball, Gannett, and Dailymotion and the company through its platform enables these publishers to increase their ad revenues by increasing the video ad relevancy to site visitors. LiveRail also provides marketers with access to video ad inventory and information needed to determine where to place ads.

Strategically it's an important acquisition for Facebook, as it would increase the company's scale and insight on video ad delivery. As the company rolls out video ads to its main site, LiveRail's ad tech platform can help it better target its users. LiveRail delivers 7 billion video ads a month. Brand advertisers require scale when they run video campaigns and LiveRail can provide FB with the reach to run targeted campaigns across multiple sites. On the other hand Facebook can also improve LiveRail's own business by adding its targeting capabilities through its huge knowledge of data to LiveRail's customers.

Zuckerberg has set an exceptionally high bar for the video ads and is taking extra measure to make sure video ads are not distracting. He wants to strike out a balance between users comfort and commercial opportunity. LiveRail acquisition will provide Facebook with that much needed expertise on video ads.

Facebook Audience Network

FB also recently announced its mobile advertising network, Facebook Audience Network ("FAN"). Zuckerberg believes that the fragmented mobile ecosystem needs a better way to deliver more relevant personalized ads, and FB is well-positioned to provide a highly-personalized product for developers and users.

A Facebook ad network, a logical next step for the company, has the potential to be a game changer for the company. Facebook has a huge database of over 1 billion mobile monthly active users and FAN allows FB to leverage that database to open up a new revenue stream without impacting the user experience on its main Facebook app. Over the years Facebook has perfected targeting precision on its core product and now it is bringing it to the rest of the mobile web.

Facebook continues to impress with the progress it has made on mobile. The company's more than 1 billion monthly users and the richest customer profile database under one platform, enable the company to serve up some of the most targeted mobile ads the world has seen yet. Moreover, an ad network gives Facebook the ability to leverage the rich profile data the company has generated across its user base and provide advertisers with targeted advertising all without disrupting the user experience on Facebook-owned sites.

Bringing It All Together

Advertising trends are changing rapidly and identification and personalization will be a core driver of advertising growth going forward. Facebook provides advertisers the ability to target that is not available anywhere else on the social media if not the whole internet and that is precisely the reason more and more advertisers are turning to Facebook to build a brand. As I mentioned in the beginning other than Google there is no other platform where advertisers get the ability to target at the scale that FB provides.

Facebook's next big task to unlock the growth potential it has in advertising is to improve the measurement of advertising placed on Facebook. On that front, the company is already working closely with its partners such as Datalogix. As the company continues to refine its measurement tools and return on investment metrics become more integrated, it won't be long before Facebook becomes a must for advertisers. The enviable position that Facebook has built over the years and the progress it continues to make in mobile, it won't make sense for advertisers not to be utilizing this platform.

Valuation

Facebook is trading at current price/earnings ratio of 88x and forward price/earnings ratio of 37x. Taking into account the growth prospects of the next two year, I don't think the company is trading at a premium. I think the current valuation is quite reasonable. I believe the market is underestimating the monetization potential of FB's new products and services. Facebook is expected to grow its revenue by over 40% in the next two years, with 2014 expected revenue growth of over 50%. Going forward, deep levels of mobile engagement should translate into meaningful levels of mobile-sourced revenues for FB.

Conclusion

Facebook is firing on all cylinders. Its performance has been outstanding as users continue to grow, margins remains strong, and topline growth beats consensus. The company, after the acquisitions of WhatsApp and Instagram, now has 3 successful products in its portfolio and each caters to different and sometimes overlapping consumers. I expect Facebook to continue its policy of strategic acquisitions not only to prevent a possible market share loss but also to increase its revenue and earnings growth. Facebook, in order to monetize its potential, needs a larger demographic of users and that explains why Zuckerberg is embarked on developing multiple brands.

Although the market is questioning the Mark's strategic decision making capabilities because of the price at which the acquisitions are being made right now, I believe these acquisitions would prove themselves worthy by increasing both revenues and user base. Moreover, I see the current path followed by the company and the development of multiple brands as a strong strategic value proposition and would also like to see the continued growth through smaller strategic deals to remove the associated uncertainty and the free cash flow constrain which might occur.

Source: Facebook: Firing On All Cylinders; A Deep Product By Product Dive Into This Social Media Giant