These Scenarios Could Impact Facebook’s Stock

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Facebook’s (NASDAQ:FB) stock price has risen by around 40% over the past year on the back of its increasing monetization and growth of its user base. Though our $87.83 price estimate for Facebook’s stock, represents near-10% premium to the market, we believe there are certain plausible scenarios that could move the stock considerably over the coming years, assuming the market prices in these triggers correctly. Specifically, we think the possibility of better-than-expected monetization of the Search and Messenger businesses could yield upside to our valuation.  Conversely, lower-than-expected growth in revenues from Instagram and WhatsApp would induce a stock price change  for the worse. Let us consider these alternative scenarios in tandem.

See our complete analysis for Facebook

Monetization Of Search And Messenger Causes Ad Impressions To Rise By 11% Annually (+10%):

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While the number of ads delivered increased by 32.0% and 20.0% in 2012 and 2013, respectively, it fell significantly by 40% in 2014.  Contributing to the decrease were the increased proportion of news-feed ads (which are fewer in number but more prominent) and trends towards more mobile usage (where lesser ads can be shown due to smaller screen size). Though we forecast the number of ads delivered to drop significantly in 2015 as well, we estimate the figure to grow at around 8% CAGR over the 2016 to 2021 time frame. This is based on the rationale that ad impressions growth will at least follow the increase in overall monthly active user (MAU) base, as more users will directly result in additional ad inventory. We forecast overall MAU base to increase at around a 5% compounded annual growth rate over this interval, and hence this could be the base level of growth for ad engagements on Facebook. Additionally, we think engagement levels for international users will increase over our review period with faster net connectivity across developing markets and increased adoption of smartphones. Further, the addition of ads in Search and Messenger could contribute to increased ad engagements on FB’s platform.

Under a scenario wherein the total number of ads delivered increases by 11% annually over our forecast period, versus the 8% rate we use in our published model, then it would take our price estimate 10% higher to $97. We believe this alternative scenario is plausible on account of the following factors:  1) more than one billion searches are undertaken on Facebook daily through the mobile platform, and since Facebook has access to unique data on users’ interests and recommendations, the same can be leveraged to serve targeted ads; 2) the transition of Messenger into a separate platform hosting third-party apps and business-oriented features  could make the platform attractive for marketers; 3) Facebook can innovate to develop new mobile apps, which would allow more ad inventory to be served; and , 4)  the increasing size of screens in newer smartphones could directly translate into more ad impressions.

Revenue Contribution From Instagram And WhatsApp Increases To Only $7.5 Billion By 2021 (-10%):

Noting the user bases of 300 million and 800 million on Instagram and WhatsApp, respectively, we believe these platforms represent large sources of value in Facebook’s stock. In our model, we have conservatively pegged average revenue per user (ARPU) on Instagram and WhatsApp at $9.00 and $5.00, respectively, in the out years  (i.e., to 2021), based on bench-marking with other similar apps and on strong engagement levels on these platforms. The monetization on Instagram will be benefit from the secular trends towards digital advertising and from the  visual character of its platform, which allows for creative delivery of ads. In contrast, while advertisements seem an unlikely route to monetization on WhatsApp, this platform can generate meaningful revenues through other methods, such as in-app purchases, payments, charges for extra features and value-added services.

Under a scenario wherein the ARPU from Instagram and WhatsApp respectively reaches only $5.00 and $2.50 by the end of our forecast horizon (half of our original estimates), there would be a 10% decrease in our price estimate to $79. A few factors that make this scenario plausible include:   1) Facebook moves slowly in monetizing these apps, in order to keep the user experience optimal; and, 2) increased competition from rival apps and other mobile apps leads to lower engagement rates on Instagram and WhatsApp.

Revenue Contribution From Instagram And WhatsApp Rises To Over $22 Billion By 2021 (+10%):

In contrast to the above bearish scenario, another scenario is plausible where ARPU on Instagram and WhatsApp reaches $15.00 and $7.50 respectively by 2021. This bullish scenario is achievable in the event these apps continue to gain popularity and command similar levels of engagement in the future. Also, this scenario will be plausible if Facebook comes up a clear monetization plan for these apps, and moves aggressively in generating meaningful revenues from these platforms. However, the ability to monetize these apps will also depend on the resulting user experience, as we expect Facebook to keep a high priority on user engagement in the future, to retain and grow its user base.

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