Facebook's Mobile Business: Where Is It Headed?
Facebook's ( FB ) recent growth can be hinged to its success in mobile monetization. Over the past one and a half years, the company has ramped up its quarterly mobile ad revenues from nothing to over $1 billion, thanks to the adoption of its feed-based ads. While it has got the aesthetics of ads right, it was the analytical capability that helped it target the right customers and generate attractive ROI (return on investment) for its customers. Facebook intends to build upon this success by bringing more mobile analytical capabilities in-house. The company currently works with 13 mobile ad partners but this dual approach will minimize risk and help it increase its dominance in the global mobile advertising market. Our current price estimate for the company stands at $45 , implying a discount of about 30% to the market price. In order to justify the current valuation, we estimate that Facebook will need to capture around 45% of the global mobile ad market by 2017, which is going to be an arduous task.
Growth In Mobile Usage And Mobile Advertising Market
Global smartphone shipments are on the rise and totaled roughly 968 million for 2013. Smartphone sales jumped 36% in Q4 2013 and constituted roughly 57.6% of total mobile phone sales as compared to 44% during the same period a year ago. Developing economies including Latin America, the Middle East and Africa, Asia/Pacific and Eastern Europe saw their smartphones sales surge by over 50% during the fourth quarter, contributing most to the global growth. IDC forecasts smartphone shipments to grow to 2.3 billion by 2017 and, as we saw in the fourth quarter of 2013, much of this growth will come from emerging markets.
Emerging countries include over 85% of the world population, and contribute almost three quarters of global GDP growth, according to Fidelity Investment Ltd. Unlike developed countries where smartphone penetration is above 50%, it is below 25% in many developing countries. While the majority of the population in these countries are below the poverty line, the elite and aspiring middle class make up nearly 20% of the population. However, as economic development gains traction in these countries, many households are expected to move to the higher income bracket in the future, increasing the demand for smartphones. While the adoption of smartphones in developed countries fueled the first wave of global growth, strong demand in emerging markets, especially Brazil, Russia, India and China (BRIC), will drive the next phase.
With the advent of smartphones and other Internet enabled mobile devices, the digital advertising market has also seen an unprecedented growth. A significant portion of future growth will come from mobile where Facebook has a strong presence. According to a December 2013 eMarketer report, mobile platform accounted for roughly 22% of U.S. digital ad spending in 2013, compared to less than 3% in 2010. According to Gartner, global mobile advertising market could hit $41.9 billion by 2017.
Facebook's Mobile Performance
In Q1 2012, Facebook had roughly 488 million monthly active users on mobile devices, which accounted for 54% of its total monthly active user base. By Q4 2013, this figure jumped to 945 million and as of today, around 80% of its monthly active users are on mobile. Like other Internet companies such as Pandora, Google, Twitter and LinkedIn, Facebook has also ramped up its mobile ad business significantly in the last two years, taking advantage of its user base growth. It began rolling out mobile ads around mid-2012 and, in Q3 2012, these ads accounted for 14% of its overall ad revenues. The continued ramp-up of ad density, an impressive increase in ad pricing driven by strong ROI (return on investment) for businesses, and increased demand for ad inventory due to Facebook's massive reach have fueled mobile ad revenue growth. By Q4 2013, mobile platform's revenue contribution increased to 53%, surpassing $1 billion in quarterly revenues. The fourth quarter also saw ad pricing growth of 92%.
If Facebook were to capture 25% of the global mobile ad market by 2017, it would be generating annual revenues of $10 billion from the mobile platform alone. This seems plausible given the annualized run rate has already surpassed $4 billion, and we have priced these expectations in our valuation for Facebook. However, if the company were to justify its current market price, it will need to capture roughly 45%-50% of the global mobile market by 2017, which will imply $20 billion in revenues from mobile alone (this assumes 70% of the company's revenues will come from mobile). This seems highly unlikely which puts its market valuation under doubt.
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