Here’s Why Instagram’s Business Will Become Huge For Facebook In The Future

In our latest model for Facebook (NASDAQ:FB), we have modeled the company’s value at $258 billion. A significant chunk (around 20%) of this valuation, is driven by our estimates on the monetization potential of Instagram and WhatsApp. We believe Facebook could generate over $6.5 billion annual revenue from Instagram in the long-run, based on our estimates on the ARPU potential on Instagram.

We think Instagram’s ARPU could reach $9.00 in the long-run, owing to factors including:   1) rapid user growth on the platform, coupled with high engagement levels; 2) strong demand for social media and mobile ads over the coming years; and,  3) increasing traction among brand advertisers, who are seeing high engagement levels on Instagram, owing to its visual platform and the rollout of video ads.

See our complete analysis for Facebook

Here Are The Key Factors That Will Propel Monetization On Instagram

Strong Demand In The Internet Advertising Market

The digital advertising market is poised to rise rapidly over the coming years, in line with the increasing ubiquity of smartphones and PCs, coupled with improvement in ad measurement techniques. Sized at more than $35.5 billion for the nine months ended September 2014, the digital advertising market in the U.S. is estimated to achieve a CAGR of 12.5% during 2014– 2019 to reach $103.4 billion, according to Forrester Research. ^{[1] [2]} A rapid rise in mobile ad spending is expected to fuel this growth, as the mobile platform is presently under-penetrated within advertising budgets. Though consumers in the U.S. spend more time on mobile devices than on TV, the mobile platform comprises merely around 5% of the average brand advertising budget. ^[3].

Mobile ad spending is expected to rise at a stellar pace over the coming years, and could account for around 16% share of the overall U.S. ad market by 2019, according to Forrester. In addition, social media ad spending is expected to rise at the highest pace within the overall digital ad market, at about 18% CAGR over 2014– 2019. ^[1] We expect mobile and social media ad spending to pick up in the international markets as well, following the trends in the U.S. market. We believe these developments will fuel monetization on Instagram in the future, considering that the mobile app is rapidly gaining traction among advertisers and is seeing high engagement levels among users.

Impressive User Growth And Engagement Levels On Instagram

Instagram’s user base has risen at a phenomenal pace over the past two years.  After crossing the 100 million mark in February 2013, its user base swiftly reached 200 million in March 2014 and 300 million in December 2014. ^{[4] [5]} This implies that Instagram added over 100 million users in just nine months, at about 11 million users monthly. We expect this momentum to persist in the coming years, although the growth rates could narrow in the future. The photo-sharing app has gained popularity among younger users across the world, and since older users generally follow younger users in adopting Internet trends, we believe Instagram’s user base will continue to rise rapidly over our forecast horizon.

In addition, engagement levels are high on Instagram, as users were recently known to spend an average of about 21 minutes daily on the photo-sharing app. We think these engagement levels could even trump Twitter’s engagement levels, which commands about 288 million monthly active users. All these metrics play well for Instagram’s monetization potential in the long-run.

Promising Early Results From Advertising On Instagram

Instagram’s visual platform allows for creative delivery of ads, and this raises its value proposition among marketers. A limited set of brands such as Taco Bell, Ben & Jerry’s, Hollister, and Michael Kors advertised on the photo-sharing app during 2014, and their results were promising. A majority of these brands saw a significant lift in their ad recalls on the platform. According to an analytics company ‘Socialbakers’, engagement rates for average posts by top brands on Instagram stood at 3.31%, which was almost 50 times as compared to 0.07% engagement rate for average tweet by similar brands. ^[6] Based on these results, and with the rollout of video ads on the platform, we expect marketers to increase their advertising footprint on Instagram.

Taking into account all these drivers, we have conservatively estimated Instagram’s average revenue per user (ARPU) to rise to $9.00 in the long-run. This is comparable to the present advertising ARPU for Facebook on its core platform. In the event, this figure rises to $20.00 by the end of our forecast period, then it would represent over 10% upside to our price estimate.

Our $87.5 price estimate for FB’s stock, represents around 10% upside to the current market price.

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1. Digital to Overtake TV Ad Spending in Two Years, Says Forrester, Advertising Age, November 4, 2014 [↩] [↩]
2. Q3 2014 Internet Advertising Revenues Hit $12.4 Billion, Making it the Highest Quarter on Record, Interactive Advertising Bureau, December 18, 2014 [↩]
3. Why Do Brands Have Such Small Mobile Advertising Budgets? [Study], ClickZ, September 16, 2014 [↩]
4. Instagram Hits 100 Million Monthly Users 28 Months After Launch, TechCrunch, February 2013 [↩]
5. Instagram reaches 200 million users, theguardian, March 2014 [↩]
6. Now Instagram Is Dominating Twitter In Another Hugely Important Way, Business Insider, December 2014 [↩]