Shares of Facebook Inc. have had a solid year so far. FB stock looks set to continue the rise, driven by strong growth at Instagram.
Shares of Menlo Park, California-based Facebook (NASDAQ:FB) have delivered a strong performance this year. The FB stock price is up by 31.6% year-to-date (YTD), leading the FAANG group of stocks. Facebook stock has beaten the market benchmark comprehensively, making the Nasdaq Composite's (INDEX:COMPX) 14.3% YTD returns look pretty ordinary. A large part of this rally in FB stock has been driven by the rise of Instagram, which has come at a time when the core Facebook platform is experiencing a slowdown in its ad loads, which was viewed as a potential drag on the company's overall growth. However, the FB platform has continued to power ahead, crossing a milestone of 2 billion users recently. Instagram has been an add-on to these growth numbers.
The Rise Of Instagram
Instagram first started to test advertisements in user feeds in late 2013. However, the platform really started to pull in meaningful revenues in 2015, a year which saw the photo sharing platform generate over $1 billion in revenue. Instagram revenue grew to over $3 billion in 2016, according to previous estimates from Credit Suisse. While there are divergences in expectations for this year, Wall Street expects the Kevin Systrom founded platform to generate revenue of $4 billion in 2017. Credit Suisse expects the photo sharing platform to generate $6.4 billion in revenue this year, coming in at the high end of Wall Street expectations. However, if we consider the rapid user and advertiser growth on the platform, Instagram is likely to crush these estimates. Instagram now has over 700 million active users and a million advertisers on the platform, and as we had pointed out in an earlier post, the accelerating rate of growth is simply astounding. So why do we think Instagram will crush Wall Street expectations?
Is Wall Street Underestimating Instagram Potential?
The simple answer is that Wall Street consensus is currently underestimating Instagram. In fact, based on our internal estimates, Instagram looks set to crush even the high end of Wall Street estimates (at $6.4 billion). The Instagram story is far more valuable than what Wall Street is currently consensus implies.
Facebook's overall ad revenue came in at $17.08 billion and $26.89 billion in FY 2015 and FY 2016, respectively. The comparable numbers for Instagram were $1.095 billion and $3.198 billion, respectively. Using the active user numbers disclosed by Instagram over the years, we calculate the ARPU (Average revenue per user) for the photo sharing platform as $6.24 in FY 2016, which was a 106% year-over-year improvement over $3.02 in FY 2015.
Wall Street currently expects Facebook to report FY 2017 revenue of $38.53 billion. Based on the recent trend in Facebook's top line composition, 97.5% of this revenue will likely be attributable to advertising, while the rest will come from payment and other services. In order to arrive at our Instagram ARPU calculations for FY 2017, we assume that Instagram will end this year with 800 million users, which is a very conservative estimate given that the platform added the last 100 million users in just under 4 months. This will be up from 600 million active users in December 2016. We now calculate the ARPU using the $4 billion Wall Street consensus and an average active user base of 700 million MAU. Based on these numbers Instagram's ARPU comes in at $5.71 for FY 2017, implying an 8.4% YoY decline in ARPU. Given the strong growth in advertising on Instagram, an ARPU decline looks very very unlikely.
Given the rapid advertiser growth (4x growth in last 1 year) and user growth on the platform (33% YoY growth based on 800 million users at end of FY 2017), ad revenue growth on the platform will likely accelerate this year. Even assuming a 50% ARPU growth in FY 2017, Instagram could generate revenue of over $6.5 billion this year, which will be $100 million above the top end of the estimate. In other words, Instagram revenue in FY 2017 could be $2 billion higher than the current Wall Street consensus, which could be more than enough to see Facebook continue its history of crushing Wall Street estimates. (Given below are our estimates)
Facebook stock has had a solid year so far, leading the FAANG group of stocks with returns of over 31% YTD. However, FB stock will likely get good support from underlying fundamentals which will be boosted by strong growth at its photo-sharing platform, Instagram. The platform looks set to crush analyst estimates by a huge margin, which should help parent Facebook generate strong revenue/earnings growth in FY 2017. All in all, Facebook stock continues to remain a good long-term buy and investors should use the recent dip to accumulate Facebook shares on the cheap. Facebook stock is among our top stock picks from the tech sector, which have outperformed the NASDAQ by over 128%.
Interested in automotive stocks? Then, we also have our top picks from the auto sector, which have beaten the S&P 500 by over 206%. If you're a trader though, you should check out our daily trading ideas section for daily, free updates on the latest crossovers and other popular technical signals.