Facebook (NASDAQ:FB) reports 2Q16 on Wednesday, with consensus expecting $0.81 in EPS and $6.0B in revenue split between advertising ($5.8B) and payment ($0.2B). Consensus also expects MAU of $1.689B and DAU of 1.139B, implying an engagement rate of 67%. My thesis on FB is that its strong network effect, superior ad product, mobile penetration and long-term growth in mobile messenger, virtual reality, payments, wireless services and online video deliver multiple catalysts in the coming decade. When we look at the secular trends in mobile advertising, fintech, VR and messaging, FB is uniquely positioned to not only benefit from all these trends but potentially become the leader in these respective segments. Current valuation of 26x 2017E earnings does not appear to price in these growth segments, which is why I feel that FB remains undervalued in the market and that the current share price does not reflect FB's potential.
I reiterate FB being my top pick within the social networking service vertical given its solid financials supported by the strong operating metrics. Long-term investors should consider FB since it is perhaps the best idea among the large-cap Internet companies.
MAU growth, video and non-social network segments will be in focus.
FB has consistently delivered active user growth in all geographic segments, but future growth will be coming from emerging markets such as India and Latin America, as North America and parts of Europe face market maturity. India and ASEAN will likely be near-term drivers for FB's user growth. With over 1B population, educated workforce and large English-speaking group, India is an attractive growth market for FB given its near-term uncertainties in entering China.
FB continues to steal ad dollars from TV (see - Facebook: Taking A Bigger Share Of TV Ad Dollars) and I expect video ad products to deliver another quarter of solid results. The recent product rollout of real-time sports is a positive as it could potentially open up to FB acquiring sports media rights in the future, a scenario that is quite probable given FB's position as one of the largest media distributors globally. We saw clear signs of FB taking ad dollars from TV as the platform generated close to 10B daily video views. Looking at the long term, video consumption in FB could give the company the opportunity to venture into content broadcasting in combination with virtual reality.
Non-core projects in Messenger will be in focus. On the Messenger front, FB is already ramping up its Messenger with VoIP, P2P payment and local services that could make it competitive against the Asian messenger apps. More recently, FB Messenger has surpassed the 1B active user mark and this sets the foundation for monetization. In my view, focusing on payment-oriented functions not only rejuvenates FB's payment service which has been sluggish in recent years due to the declining popularity of its games but also builds a competitive payment platform that one day could potentially rival Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) and Apple (NASDAQ:AAPL) Pay (see - Facebook: Building up its payment network). Ultimately, I see FB's mobile Messenger eventually replacing credit cards at point of sales via QR-code scan so payments are routed directly from the user's FB Messenger account to the merchant. This feature is already being used by Tencent (OTCPK:TCEHY) and Alibaba (NYSE:BABA) in stores across China, and I believe that it is only a matter of time before it is rolled out in the U.S. (see - Alibaba: Setting An Example In Mobile Payments).
On VR, I still see a lot of potential here, although recent success by Pokemon GO clearly showed that augmented reality, rather than VR could potentially be the future. I expect questions to be focused on how FB is going to mass commercialize the Oculus Rift. Although the price appears to be reasonable (see - Facebook And Oculus Rift: The Price Is Right), it is still a product for the early adopters so analysts could focus on the launch of Oculus PC next month. In my view, virtual reality and social networking could be a game changer to FB as it brings social interaction to a whole new level and drive engagement higher.
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