Facebook has a clear strategy, which would help the company succeed in its mission to give people the power to share and make the world more open and connected. The company has three set goals:
1) Connecting everyone
2) Understanding the world and
3) Building the knowledge economy.
Recent company events underscore the company’s clear strategy to achieve the goals set. In this article, I will focus on how the company’s recent acquisition of WhatsApp is in line with the company’s strategy. I will also discuss the growth drivers which would have considerable impact on the company’s revenue.
Before looking at the future growth prospects of the company, it is important to discuss about the company’s financial performance. For the first quarter of 2014, Facebook’s revenue increased by a robust 72% to $2.5 billion year-over-year. The increase was primarily due to increase in total ad-revenue by 82% to $2.3 billion with ad-revenue up by over 70% in all the four geographical regions.
Mobile ad-revenue was also up from $377 million in the first quarter 2013 to $1.3 billion in the first quarter 2014. The financial growth underscores the tremendous opportunities for Facebook in advertisement sector.
A positive financial observation is that the company has been able to increase its free cash flow in spite of increasing capital expenditure over the years. FCF has increased from $381 million in 1Q13 to $922 million in 1Q14, which implies the company has enough cash to pursue new opportunities and hence create shareholder value.
Acquisition of WhatsApp
Investors were wary about the company’s decision to acquire WhatsApp for $19 billion. However, the company’s decision was appropriate and was taken at the right time. I will discuss how this acquisition will benefit Facebook in achieving its goals of growth and creating a best communication tool.
Connecting everyone aims at making internet service available to everyone and making it easy to connect and share things, which people care about. However, Facebook connectivity is at its mature phase and apps like Instagram and WhatsApp would act as growth drivers for Facebook.
Through the acquisition of WhatsApp, Facebook has taken a step forward to increase its user base for a more convenient real time communication. WhatsApp currently has more than 450 million monthly active users of which approximately 70% are active on a given day. The number of users is increasing by more than 1 million per day and this provides a big market for Facebook.
If we look at the company’s revenue breakup by geography, U.S and Canada is the largest contributor. However, for WhatsApp the market share and user base is strong internationally, as the company has been growing in Europe, India and Latin America. This acquisition will also help Facebook to diversify its revenue sources outside US, where the growth potential can be meaningfully higher.
Source: Company Presentation
Relevant Ads Will Boost Ad Revenue
Facebook’s goal of building knowledge economy will also be met by the company’s decision to focus on relevant ads for users. It aims at creating technology platforms, which everyone would use to do their jobs in a better and an efficient way.
Advertisement is one such technology, which the company aims at making full utilization. For couple of years, the company has been benefitting with its focussed strategy of an improved relevant advertisements.
To boost the company’s ad revenue, Facebook has come up with new ways to make search easier for uses. Earlier, the company used to learn about users interest from the activities they do on the Facebook website itself, such as liking or browsing a page. But now, Facebook will gauge out information from other websites or apps the users have been using.
Companies like Google (GOOG) and Yahoo (YHOO) had already been using this strategy, but what is unique for Facebook is that users can opt out of such advertising procedure. In addition to this, the company would allow the users to have a better control on the ads they see.
In this relation, Facebook will roll out a new ad preference tool which could be viewed with every ad on Facebook. Users can easily click on the ad and decide not to see or hide all the ads from the advertisers, thus giving a better control on the users’ preferences.
For 1Q14, ad relevance has had a positive impact on the company’s ad pricing. There has been 118% increase in the ad pricing in 1Q14 over the last quarter. It is also important to note that the shift of relevant ads from desktop to mobile has resulted in considerable impact on the company’s revenue as 55% of daily active users log in through mobile devices.
As discussed Facebook has a focussed goal and the company has been strategically working to achieve them. What I like about the management is their clear strategy of monetization, which is already yielding positive results for the company. Further, the recent acquisitions will help Facebook to increase their daily active users globally. I would hence prefer this stock in spite of it being slightly overvalued as the company has high growth prospects which will discount the current overvaluation.