This post is written by Jim (Jiecheng) Huang, Integer Investments analyst.
With over 2 billion monthly active users, Facebook (FB) is the most popular social media networking site. It dominates the social media market worldwide, with the exception of China, Russia and a few other countries. In addition to its core Facebook website and app, Facebook has acquired over 60 companies. Some major acquisitions include WhatsApp, Instagram and Oculus. As shown below, with acquisitions like these, Facebook owns three out of the five largest social networks worldwide.
For the past year, Facebook share price has increased by nearly 37%, it is hard to imagine a company dominating the industry but still growing at such an unbelievable rate. This article will discuss the growth potential of Facebook, it can be separated into organic growth potential from existing business units and acquisition possibilities. In order to provide a detailed comparison, we will only be discussing the organic growth potential in this article and leave acquisition possibilities for a later date.
(Source: Google Finance)
Facebook’s ability to grow at this unbelievable rate is one of the key reasons why many investors are interested in the company. Total revenue is growing by a tremendous 45% year over year to $9.3 billion, and advertising revenue is up 47% to $9.2 billion in Q2 of 2017, but Facebook's revenue growth is actually slowing down. As Facebook CFO David Wehner suggested, revenue growth will slow down in the second half of 2017. Hence, it is extremely important for us to understand how Facebook can continue to grow.
(Source: Created by the author based on Facebook’s Q2 2017 Results)
Organic Growth Potential
There are different business units that are generating revenues for Facebook, but as shown in the chart below, over 98% of Facebook’s revenue comes from advertising. This indicates that most of the revenue are coming from the flagship Facebook website/apps and Instagram, as opposed to other business units such as Oculus. Hence, we will focus on the growth potential of these core social media platforms as opposed to Oculus VR.
(Source: Facebook’s Q2 2017 Results)
There are three ways to how organic growth can happen within Facebook’s social media platform: growing the user base, increasing the ARPU and generating a new source of revenue. We will now examine each of these ways in detail.
Growing The User Base
After taking a constant decline until late 2015, the growth of monthly active users (MAU) and daily active users (DAU) have been consistently strong for the past few quarters. Despite it showing a slight increase regarding the growth rate of MAU and DAU, it becomes increasing difficult to maintain this upward trend.
(Source: Created by the author based on Facebook’s Q2 2017 Results)
One of the concerns with regard to growth in MAU and DAU is the fact that the world population only grows at 1.1% per year, which is nowhere close to the 17% that Facebook is experiencing. However, with the world population of 7.5 billion and only a 51.7% internet penetration (able to access internet) around the world, there is room to grow from the unconnected population.
MAU and DAU are affected by two things, the availability of internet within that particular region (Internet penetration rate) and the willingness to use Facebook when internet is available (Facebook penetration rate). As shown by the chart below, only North America/Canada and the Europe region have an internet penetration rate of 80% or above. While other regions such as Asia and Africa, the internet penetration rate is below the world average of 51.7%. Hence, as internet penetrates around the globe, we will expect MAU and DAU to increase alongside.
(Source: Created by author based on Internet World stats)
Internet penetration of each country ranked by their population explains why the Asia and Africa region is particularly low in comparison.
(Source: Created by the author based on Internet live stats)
To examine the willingness to use Facebook among internet users (users with internet availability), we took the MAU announced by Facebook in Q2 of 2017 and compared that against internet users within that particular region. As expected, the US and Canada region shows the highest “Facebook penetration rate,” nearly 74% of internet users in the US and Canada are considered MAUs of Facebook.
The growth might be relatively low, but this does indicate that even in the US and Canada, there is room for Facebook to grow. The Asia-Pacific region would seem a lot more prominent as the “Facebook penetration rate” is still very low and it is growing at the highest rate among all regions.
By 2024, Forbes forecasts the number of Facebook users in the US and Canada region to be 261 million. This gives an implied year-over-year MAU growth rate to be less than 1.5%. Based on the current trend and guidance from Facebook management, we expect MAU growth to slow down. The US and Canada region has been growing between 4% to 6% in the last nine quarters, so it should easily achieve a 2% to 3% year-over-year growth in MAU in the future. For other regions, we expect a similar growth rate until the percentage of MAUs among internet users for that particular region reach over 70%.
(Source: Created by author based on Facebook’s Q2 2017 Results)
Average Revenue Per User (ARPU)
It is obvious that the US and Canada region is the most important for Facebook, as it makes up 49% of Facebook’s revenue. More importantly, users within the US and Canada region generate a lot more revenue in comparison to other regions. In Q2 of 2017, each US and Canada user generates $19.38, which is over three times of what Europe users generate, $6.28.
(Source: Facebook’s Q2 2017 Results)
This difference in ARPU between the different regions may also suggest a huge upside for regions outside of US and Canada. This could indicate a tremendous long-term growth potential, as the possibility for Europe or other regions to potentially reach the same height as US and Canada in regards to ARPU is exciting for investors. But we need to first understand why a single US user is more valuable than a single user in other regions such as EU.
There is no definite answer to this question, but there are two potential reasons. There are more US and Canada businesses that are advertising on Facebook than European businesses. US and Canada GDP per capita is higher than other regions, so users from those regions are more attractive to businesses.
When businesses want to create ads on Facebook, these businesses are required to select their ad audiences by countries or regions. With over three million businesses advertising on Facebook, nearly 30% of these businesses are based within the US, together with the business outside of US but are targeting US and Canada audiences, there are potentially over 40% of the businesses that are advertising on Facebook to target US and Canada users. However, with over 2 billion MAUs on Facebook, only 11.8% of them come from the US and Canada region. Hence, it makes sense why US and Canada users are more valuable.
The differences in ARPU could be heavily influenced by the difference in GDP per capita between regions, as the US and Canada region is much higher than other regions. The GDP per capita for the Europe region might seem a bit low as it includes both Eastern and Western Europe, which is also how Facebook splits the regions.
By taking GDP into consideration, we calculated the regional ARPU as a percentage of GDP per capita for that region. For example, in 2016, the ARPU for the US and Canada region is $62.23 for the year, with a GDP per capita of $43,786, the average revenue generated by users in US and Canada is 0.142% of its GDP per capita.
This is very high in comparison to the 0.075% from the Europe region and it can suggest growth potential waiting to be discovered in terms of ARPU for the Europe region, as users in Europe are simply yet to be targeted heavily by businesses using Facebook ads. Unlike the Asia-Pacific region, where GDP per capita might be low, the ARPU as a percentage of GDP per capita already is at 0.115%, which is fairly close to the US and Canada region.
To answer our initial question of why users within the US and Canada region generate a lot more revenue in comparison to other regions - GDP per capita is definitely a contributing factor, but it is also because US and Canada businesses are promoting themselves more on Facebook in comparison to Europe businesses.
The Europe region users hold the hardware requirements in terms of a high GDP per capita (purchasing power), but European businesses are not as active as US and Canadian businesses on Facebook. So as soon as European businesses begin to advertise on Facebook and target European region users as heavily as US and Canadian businesses, we should see a spike in Europe ARPU.
On the other hand, investors might be concerned with a decline in ARPU from US and Canada region as opposed to an increase in regions such as Europe, but this is extremely unlikely. The only way for ARPU to decline is for businesses in US and Canada is to withdraw ads on Facebook while MAU increases. But as more and more businesses are willing to put ads on Facebook, it suggests ads on Facebook does improve the bottom line for these businesses. Hence, there is no way that they will withdraw ads from Facebook.
(Source: Created by author based on data from IMF and Facebook Results)
When examining the year-over-year growth of ARPU between the different regions, we observed a steady decline in the US and Canada ARPU growth. From its peak at 54.19% in Q2 of 2016 to the current 35.15%, but it remains the region with the highest growth. Although the Rest of World region shows an increasing trend until Q2 of 2017, other regions such as Europe, Asia-Pacific and Worldwide hold similar trends as US and Canada.
As stated by the CFO of Facebook in past earnings announcements, they continue to expect ad revenue growth rates to come down as the year progresses. We should expect year-over-year ARPU growth rate to continue to decline in the near future. However, a 25% to 30% YOY growth of ARPU for the US and Canada region seems reasonable for the next few quarters.
(Source: Created by author based on Facebook’s Q2 of 2015, 2016, 2017 Results)
Monetization Of Messaging Apps
Monetization of messaging apps such as Facebook Messenger and WhatsApp is definitely one of the most promising ways for Facebook to generate additional revenue. With over 1.2 billion monthly active users on Facebook Messenger and 1.3 billion monthly active users on WhatsApp, the revenue potential is enormous.
Facebook has decided to focus on advertising as the monetization model. Facebook’s VP of messaging products, David Marcus, stated that “The one thing we traditionally do, and is a decent business for us, is advertising. So, we’ll continue focusing on that.” However, monetization on Messenger can be difficult and dangerous if user experience decreases significantly. As mentioned in past earnings announcements, monetization is still in early stages, and it is only been used on a small group of users to examine the effectiveness of advertisements.
Facebook started slowly with ads on the Facebook Messenger home screen, as it only existed in a limited beta in Thailand and Australia. However, according to Venturebeat, ads targeted specifically to end users will be showing on Messenger's home screen across the globe by the end of 2017.
Moreover, Messenger head of product, Stan Chudnovsky, also stated “When the average user can be sure to see them we truly don’t know because we’re just going to be very data-driven and user feedback-driven on making that decision.” This shows Facebook is willing to change and adapt to user preference; this is very important as user engagement should be Facebook's first priority.
An example of a similar product would be WeChat from Tencent (OTCPK:TCEHY). WeChat has over 963 million MAUs as of Q3 2017 and is the fastest-growing monetization stream for Tencent’s advertising business. Revenue from this source is about $1 billion. This equates to a ARPU of roughly $1. On the surface, this doesn’t seem a lot in comparison to Facebook’s $19 ARPU for the recent quarter. However, with US and Canada GDP per capita being five times of China’s, an additional $3 to $4 ARPU for the US and Canada region per quarter should be easily achieved when monetization of Facebook Messenger fully activates.
Facebook has shown strong growth for the past few quarters, despite warnings of a much slower second half of 2017. We do not expect to see too much movement in the short term. A 25% to 30% ARPU growth should be achieved with ease. From a long-term investment standpoint, Facebook continues to offer growth potential in increasing the user base, ARPU improvement and monetization of messaging apps. The core US market is definitely important, but as both the internet and Facebook penetration rate continue to increase in other regions, we continue to expect strong growth even if the US market slows down.
ARPU growth in Europe will continue to increase steadily and may eventually become close to what the US and Canada region are offering. Together with the monetization of Messenger, the organic growth in Facebook is definitely promising.
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Disclosure: I/we 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.