Here’s Why Facebook’s Advertising Revenues Could Grow To Over $40 Billion By 2021

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In our latest model for Facebook (NASDAQ:FB), we estimate advertising on the core Facebook platform to account for the bulk (more than 75%) of our valuation. We expect advertising revenues on the core platform to rise from $11.5 billion in 2014 to over $40 billion in the terminal year of our model. While this will be driven by increases in both users and average revenue per user (ARPU) on the platform, the latter will be responsible for more than 70% of this increase in the top-line, in our view.

We estimate Facebook’s overall advertising ARPU to surge from $8.60 in 2014 to over $23.00 by 2021, driven by the roll-out of better and more targeted ads, high demand for social media and mobile ads, an increase in user base, and monetization on Messenger and Search.  These factors together will further propel both ad inventory as well as ad pricing on the social networking platform. Moreover, we expect international ARPU growth to outpace overall ARPU growth over the long-run, as Facebook is still under-penetrated in international markets. In the event  Facebook’s overall advertising ARPU rises much higher to $29.00 by the end of our forecast horizon, then it will drive a more than 15% increase in our price estimate.

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See our complete analysis for Facebook

Here Are The Key Factors That Will Cause ARPU Expansion Over Our Forecast Period

Rollout Of Better And More Targeted Ads Will Propel Ad Pricing: We think the introduction of better and more targeted ads will continue to drive higher monetization on Facebook. Video ads are expected to gain prominence on the social networking platform in the coming future, since auto-play video ads were rolled out internationally during the fourth quarter of 2014. The number of video views per day on Facebook surged to over three billion, as compared to one billion as recent as September 2014. With Facebook continuing to push videos on the platform — the recent F8 conference saw the introduction of embedded videos (letting users embed Facebook videos onto web-pages) and spherical videos (that provide 360 degree videos) — we believe video views will rise sharply over the coming years. Together with better ads, we also expect Facebook to improve ad targeting and measurement tools with investments in Atlas and other tools.

High Demand For Social Media And Mobile Advertising Will Boost Ad Pricing: The Internet advertising market is increasingly gaining traction, owing to increasing ubiquity of smartphones and PCs, coupled with an improvement in ad measurement techniques. Sized at over $35.5 billion for the nine months ended September 2014, the digital advertising market in the U.S. is forecast to rise at a CAGR of 12.5% between the years 2014 and  2019 to reach $103.4 billion, according to Forrester Research. [1] [2]

Much of this growth is expected to be fueled by rapid rise in mobile and social media ad spending. Though the mobile platform presently accounts for a small share of the advertising market, its share is estimated to rise to 16% in the overall U.S. ad market by 2019, according to Forrester. Moreover, social media ad spending is expected to outpace the overall Internet ad market, and grow at around 18% CAGR during 2014–2019. [2] We think social media and mobile ad spending could accelerate in the international markets as well, following the trends in the U.S. market. We believe these demand trends will support higher ad pricing on Facebook’s platform.

On account of the above given factors, we estimate average ad pricing to rise at a CAGR of around 18% over our forecast period.

Increase In Ad Inventory: Though the number of ads delivered on Facebook rose by 32.0% and 20.0% in 2012 and 2013 respectively, it decreased by 40% in 2014 because of increased proportion of fewer (but more prominent) news feed ads and shift towards higher mobile usage (where lesser ads are shown). While we expect the number of ads delivered to decrease in 2015, we forecast it to rise at 8% CAGR during 2016 – 2021. The key factors driving our estimate include:

  • We estimate the overall monthly active user base to rise at around 5% CAGR during 2016-2021. We think this could be the base level of growth for ad engagements on Facebook, as more users will directly result in increase in ad inventory.
  • In addition, we believe the number of ad engagements could surpass user growth as monetization on other platforms including Messenger and Search will provide additional ad inventory on the platform. Recently, during the F8 conference, Facebook announced various new features on Messenger, including business-oriented features and integration with third-party apps. We believe these developments could also translate into advertisements within the Messenger platform, leading to higher ad inventory.
  • Moreover, we think engagement levels for international users will rise over our forecast period with faster net connectivity across developing markets and increased adoption of smartphones. All these factors, will lead to increased ad engagements on Facebook’s platform.

In the event  the total number of ads delivered rises by 11% annually (as compared to our current estimate of 8%) over our review period, then our price estimate grows 10% higher to $96.

ARPU Growth Could Pick Up In International Markets Over The Long-Run: Though ARPU was seen at $9.00 in the U.S. and Canada during Q4 2014, it was recorded at much lower levels of $3.45, $1.27, and $0.94 in Europe, Asia-Pacific and Rest of World respectively. We think this spread in ARPU levels across different markets could decrease somewhat over the long-run, as we expect Facebook to ramp up advertising in international markets once its advertising business in the U.S. starts moving towards maturity. Hence, we expect growth rates in international APRU levels to surpass those in U.S. and Canada over the longer-run.

Our $87.5 price estimate for FB’s stock, represents around 5% upside to the current market price.

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Notes:
  1. Q3 2014 Internet Advertising Revenues Hit $12.4 Billion, Making it the Highest Quarter on Record, Interactive Advertising Bureau, December 18, 2014 []
  2. Digital to Overtake TV Ad Spending in Two Years, Says Forrester, Advertising Age, November 4, 2014 [] []