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IT software and Services industries are suffering from a fall in demand for software and web services as consumers are focusing solely on essentials and not discretionary products. That said, the industry has seen companies with a portfolio of software as well as services aimed at remote collaboration benefit due to the growing number of people globally. Many companies are also operating with employees working remotely from their own home.
For Q2 2020 Facebook, reported revenue of $21.5 billion, up by 22% y-o-y. Meanwhile, Operating Margin fell to 37% from 41% in same period of the previous year and effective tax rate fell to 4% from 17% in the same period of the previous year. This led to earnings being $2.71, up from $2.12 in the same period of the previous year. Facebook expects about higher growth in revenue for Q4 and FY 2020 compared to Q3 2020.
Below we highlight key drivers of Facebook’s value that present opportunities for upside or downside to the current Trefis price estimate for Facebook.
Facebook is the world’s most popular social network that helps people connect with family and friends. The company makes money primarily through advertising, which it provides to advertisers by targeting specific demographics based on their information posted on Facebook. Also, Facebook facilitates the purchase of virtual goods in games and applications running on Facebook’s platform, charging a transaction fee on each virtual good purchased.
This remains the most significant division for Facebook, contributing about 92% of its overall value. This high-value contribution can be attributed to two main factors: scale and user engagement. Facebook has over 2 billion monthly active users, and the user engagement within this base is also high. These stellar metrics are a result of innovative product development at Facebook, which includes Timeline, NewsFeed, Messenger, Search, and several other features designed with the long-term vision of ensuring that user stickiness to Facebook remains high. In future years, both scale and user engagement are expected to be strongly driven by growth in the mobile space.
Coupled with the highly active user base, Facebook has also achieved success with its monetization strategy. Its move to raise the proportion of feed-based ads and make the platform less cluttered has garnered success among marketers. Improvement in ad products, along with their targeting capabilities, has driven enhanced ROI and value for advertisers.
The monetization of Instagram and WhatsApp is paltry compared to some of its peers. In our view, Instagram’s 1 billion+ active monthly user base, along with high engagement levels on the platform, will make it highly attractive to advertisers. The company has begun monetizing Instagram and we believe this could start providing meaningful revenues going forward. In addition, WhatsApp has more than 1.5 billion monthly active users. We believe the monetization rate for these platforms will improve in the coming years. We think this platform can be monetized in several ways, including annual subscription fees, in-app purchases, online payments, advertising, promoted accounts, social commerce, etc.
Facebook also makes money by acting as a platform for the purchase of virtual goods on social gaming applications by partnering with gaming companies such as Zynga. Zynga’s games like Farmville and Poker have been wildly popular, enabling Facebook to extract substantial revenues from the sale of virtual goods like Poker chips. Recently, it has introduced a paywall for content providers. However, the ongoing shift towards higher mobile usage from desktop usage has caused pressure on this revenue stream. Payments from the gaming business on Facebook could decline in the near-term.
We think investments on diverse platforms (such as Messenger, Instagram, WhatsApp, Search, and Oculus) could reap multi-billion dollar businesses for the company in the long-run, and management hasn’t even begun scratching the surface of this potential. We think FB could start unlocking value in other businesses such as WhatsApp, Search, and Messenger over the coming years. Overall, we believe all these moving parts will continue to fuel the company’s top-line growth for years to come.