Here Are The Key Drivers And Barriers For Facebook’s Business

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Facebook (NASDAQ:FB) recorded a successful year in 2014, with both its business fundamentals and stock price surging during the year. In this article, we assess some of the key drivers and barriers in Facebook’s business to understand where the company could gain or lose going forward. We believe Facebook is well positioned for long-term growth considering a number of tailwinds clearly outweigh the barriers, in our view.

Most significantly, we believe Facebook’s monetization will continue to grow rapidly over the coming years, fueled by increasing adoption of mobile advertising and growth in ARPU across developed and developing markets. Moreover, the addition of new ad products, such as video-based advertising, and the improvement in ad measurement tools will boost ad pricing on the platform. Though expenses are expected to rise significantly in 2015, we believe the company is taking the right steps in positioning itself for long-term growth. We believe platforms such as Instagram, WhatsApp, Messenger, Search, etc., can become huge businesses in the long-run, and the company has not even begun scratching the surface of this potential. Notwithstanding these positives, we think competition could intensify for Facebook in the coming years through the introduction of niche social networking sites and newer mobile apps, and this could possibly limit the time spent by users on Facebook platforms on their mobile devices.

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See our complete analysis for Facebook

Key Drivers

Key Barriers

->Mobile platform is under-penetrated within brand advertising budgets 

-> Growing user base on several platforms

-> Strong monetization opportunity on non-core FB platforms

-> Strong ARPU potential (both within developed and developing markets)

-> Expenses will increase significantly in 2015 

-> Falling engagement among certain user demographics and rising competition

 

Key Drivers

The mobile platform is under-penetrated within brand advertising budgets: While consumers spend a significant proportion of their spare time on mobile devices, this platform comprises for merely around 5% of the average brand advertising budget, according to a study by Forrester. [1] This is largely due to the inability to accurately measure the return on  mobile ad spending. We believe mobile advertising will gain share in the overall advertising market in the future, with the maturity of the market and development of more accurate ad measurement tools. Facebook is uniquely positioned to gain from this trend, considering mobile monthly active users comprise for more than 85% of its overall active user base, and since the company is undertaking various measures to improve its ad relevance and measurement.

Growing user base on several platforms: Facebook added 165 million monthly active users in 2014, to grow its user base by 13% over the year. Users on FB’s mobile platforms also grew at a stellar pace during 2014.  Recently, Monthly Average Users (MAU’s) on Instagram, Messenger and WhatsApp exceeded 300 million, 500 million and 700 million, respectively. We think Facebook’s user base will continue to grow at a healthy pace in the coming years as well, owing to increasing Internet penetration across developing markets, such as India, Indonesia and Brazil, as well as rising popularity of these platforms. These user trends will lead to expansion in the number of marketers and, hence, will drive up monetization on the platform.

Strong monetization opportunity on non-core platforms: Though Facebook hasn’t begun monetizing its other platforms (including Instagram, Messenger, WhatsApp, and Search) significantly, we believe these platforms represent significant sources of value for the company. We believe each of these platforms has the potential to reap multi-billion dollar businesses for the company in the long-run. While the company is currently still prioritizing on user experience on these platforms to expand their user base, we believe monetization on some of these platforms (such as Instagram) could pick up over the next 1-2 years.

ARPU has potential to rise: Though Average Revenue Per User (ARPU) in the quarter ended December 2014 was seen at $9.00 in U.S. and Canada, it stood much lower at $3.45, $1.27, and $0.94 in Europe, Asia Pacific and Rest of World, respectively. We believe there is considerable room for ARPU expansion both within the developed as well as developing markets. We think the U.S. market would see lift in ARPU, mainly due to better and more targeted advertising, as well as the trend towards mobile advertising. At the same time, ARPU in developing markets will increase as they are largely under-penetrated by Facebook currently.

We believe the introduction of better and more targeted ads will continue to fuel ad pricing in the future. While the total number of ad impressions came down by 40% during 2014, the average ad pricing rose by 173% during the year. Online video advertising is expected to gain traction in the coming quarters, as the company rolled out auto-play video ads internationally in Q4 2014. The number of video views per day on Facebook rose to more than three billion recently, as compared one billion in September 2014. Since over 65% of these video views occurred on mobile devices, we think the continued expansion of video ads will also increase mobile monetization. Simultaneously, we expect Facebook to come up with better ad targeting and measurement tools owing to investments in Atlas and other tools.

Key Barriers

Expenses will increase significantly in 2015: Facebook’s expenses are expected to rise significantly in 2015 over 2014 levels. In GAAP terms, expenses are forecast to rise in the range of 55% to 70%, and in non-GAAP terms, they could rise by 50% to 65% annually in 2015. Capital expenditure is estimated to increase from $1.8 billion in 2014 to around $3 billion (at the mid-point) in 2015. At the same time, top-line growth could slow down in the coming quarters with tougher year-over-year comparisons. While this step up in investments may cause some margin erosion in the near-term, we believe the company is making the right maneuvers in investing heavily on areas such as people, products and infrastructure. We believe these investments will help position the company  for long-term growth and  propel earnings over the next five to ten years.

Falling engagement among certain user demographics and rising competition: Facebook’s popularity seems to be on the wane, especially among teens, in countries such as the U.S. and the U.K., according to a recent GWI Social Report [2]. Nearly 64% of the survey respondents in the age group of 16-19, within the two countries, mentioned that they were using the social networking platform less frequently. In the event, this trend gains more prominence, we believe it could spell some trouble considering older users generally follow younger users in adopting new trends over the Internet.

In addition, rising competition from the rapidly evolving mobile landscape is an area to watch out for as this could impact time spent on FB’s mobile platforms. Since the social networking space is prone to quick change, innovation and introduction of new technologies, we’d advice investors to look out for the increasing popularity of new mobile apps (in areas including social sharing, messaging, micro-blogging) as some of them could potentially be disruptive to the market. Further, social networks that target a niche user base, such as Snapchat, could intensify competition for Facebook in the coming future.

Our $67 price estimate for Facebook’ stock, represents near 15% downside to the current market price.

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Notes:
  1. Why Do Brands Have Such Small Mobile Advertising Budgets? [Study], ClickZ, September 16, 2014 []
  2. GWI Social Q3 2014: the latest social networking trends, Global Web Index, November 18, 2014 []