by Clement Thibault
In the previous two quarters, Q2 here and Q3 here, we analyzed at length a number of Facebook's (NASDAQ:FB) key metrics: user growth, monetization techniques and potential competitors. Our conclusion both times was that Facebook—at $121 a share when the Q2 report was released and $130 per share as Q3 earnings were announced—was a pretty risky play.
As of last night's close, Facebook trades at $130 and continues struggling to breach its recent range in order to push toward higher price targets, confirming that we are not the only ones with doubts regarding Facebook's ability to deliver on growth.
In our previous posts we focused primarily on the company's challenges, discussing reasons not to be optimistic about FB's share price. This quarter we're reversing that viewpoint and taking a more bullish perspective.
While we continue to recommend caution on the stock, here are five potential growth opportunities we'd like to see addressed in today's Q4 2016 earnings report that could propel the stock beyond its current all-time high of $133.5, reached on October 25.
Facebook reports today, February 1, after the close. Wall Street expects it to post an EPS of $1.34 on 8.4 billion in revenue.
1. The Facebook Platform
The real truth about the social media/networking site is that in terms of revenue, Facebook is purely an advertising platform and nothing more. It has one core revenue stream: advertisers purchasing positions in order to display highly-targeted ads on Facebook user feeds.
Of course, revenue from advertising is comprised of two factors – quantity of advertisements and revenue garnered per ad. Revenue generally starts with the interaction the user had with a certain ad. Impressions are counted when an ad is displayed to a particular user. If the user clicks on that ad, it generates additional fees for Facebook.
Right now, since Facebook indicated in its last report that revenue growth was slowing because of ad load maximization, the main driver of revenue growth should be an improvement of video-related advertising revenues. Though specifics about how these charges break down is unavailable, overall Facebook's worldwide average revenue per user was $4.01 last quarter, with North America revenue per user much higher at $15.65.
2. Video: The Next Revenue Engine
Facebook is tirelessly working to improve all business related to video. Facebook Live, an instant video streaming service, was rolled out in April of this past year. In addition, Facebook is reportedly working with content creators and is open to a revenue sharing model, in what seems like an attempt to rival Google's (NASDAQ:GOOGL) YouTube in the video arena.
Facebook Live has gained in popularity over the past few months, reaching 100 million hours of video watched per day. Since FB has already rolled out video adverts in its News Feed, other monetization channels like pre-roll or mid-roll advertising will be easier to implement.
3. Instagram
Instagram, though different from the traditional Facebook ecosystem, is similarly monetized. However, while Facebook's ecosystem has maxed out the number of non-video ads shown to users, Instagram still has room to grow in the ad quantity department. Given that Instagram is a hybrid platform, incorporating both pictures and videos, it is reasonable to expect that any breakthroughs Facebook might have regarding advertising optimization will be rapidly exported to Instagram. This is one of those places where Facebook's multiple platform approach pays dividends.
Another bullish, best-case scenario for Instagram hinges on its user demographics. Snapchat is threatening Facebook's dominance among teens and young adults. According to a Smart Insights report, Snapchat is now the second most engaging social platform for 16-24 year olds based on such metrics as time spent on the platform, but Instagram's user numbers still outstrip Snapchat— 600 million monthly users and 300 million daily users, compared to half that for Snapchat.
This past August, Instagram introduced 'Instagram Stories', offering a more casual way to share events through pictures, in contrast to the usually well-staged, artistic images commonly shared on Instagram. By releasing this feature, Instagram has taken a page from Snapchat's social media playbook: finding ways to get teens and young adults, a key demographic for advertisers, to spend more time on the platform, rather than with competitors. It's still early days, but it's certain that for Facebook as a whole, successful growth will surely include Instagram recapturing this particular, highly sought after audience.
4. Messenger
In addition to Facebook Live, in April FB also launched a new Facebook Messenger feature – chatting bots. Chatting bots are automated response tools within Messenger, able to handle relatively simple requests from users, such as delivering the latest news, or even more complicated requests, such as ordering a pizza from Domino's. The bots on their own, but more significantly their ability to handle revenue-generating requests, could have a massive impact on Facebook's future development providing even deeper penetration into the day-to-day lives of users.
Of course, bots could also create a myriad of business opportunities and more disparate revenue streams for the social media site. Bots can accept payments natively, bypassing third party sites and keeping users on FB while transactions are completed. Though these bots are still mainly in the early developmental stage, a promising opportunity for another stream of revenue not necessarily reliant on advertising exists, and a little diversification in Facebook's revenue stream, could go a long way toward proving that the company can branch out into previously unconsidered markets.
5. Highly Effective Moat
Add all of the above together and it seems pretty clear that among social networks, Facebook, with its 1.17 billion daily active users, has a pretty wide moat—most users are there because all their friends are there, users probably have years of interactive activity, comments and photographs posted on Facebook, and as the leading site for internet socializing, the critical mass of users and content needed to dethrone Facebook would be massive.
Conclusion
The points above are the central pillars of the bullish thesis for Facebook. Deriving revenue from all of Facebook's products will be a must for the company to continue to grow. There are additional services we haven’t addressed, such as Whatsapp and Oculus, a virtual reality headset purchased by Facebook in 2014 for $2 billion, which still may be a bit ahead of its time, but right now Facebook's monetization efforts toward these platforms aren't nearly as focused.
Last quarter, Facebook's P/E ratio was 62, which we thought was too high. That ratio has since dropped to 50, which we believe is a positive signal for conservative investors still looking to initiate a position in Facebook. Nevertheless, our caution designation remains in place. We prefer to wait for additional information and more promising numbers before making a call on the long term outlook for the company.