Facebook stock has been on a run. However, FB stock could top $175, driven by mobile ad revenue and Instagram growth.
Shares of Menlo Park, California-based Facebook Inc. (NASDAQ:FB) have risen steadily through 2017, after what was a relatively lackluster performance last year. FB stock price is up 16% for the year, outperforming the Nasdaq Composite (INDX:COMPX), which is up 8.5% over the same period. As outlined in our recent post, we think Facebook stock is headed even higher, driven by growth in mobile and video ads, and the rise of Instagram as a major revenue source. In this post, we will look at the potential upside and attempt to quantify the same with respect to the FY 2018 performance.
Facebook Mobile Ad Revenue Will Continue To Soar
In our previous post, we focussed on the growth in Facebook's mobile ad revenues over the last 4 years. In fact, mobile ad revenue has soared at an eye-popping CAGR of 162% over the last 4 years. However, if you think this is about to peak, think again. Facebook's mobile ad revenues are expected to soar higher over the coming years. As per eMarketer, Facebook's net mobile ad revenue is expected to grow by an average of 31.5% over the next two years. Accordingly, Facebook should net mobile ad revenue of nearly $38B in FY 2018.
Instagram Could Hit $5B In Annual Revenue faster Than Many Think
Facebook's revenue growth will also be aided by the strong growth at Instagram. With a user base of over 600M and a growing engagement makes Instagram a high-value property for Facebook. This is reflected in how ad revenues at Instagram scaled in the last year. A team of Credit Suisse analysts, led by Stephen Ju, had recently written that they expect Instagram to generate $3.2B revenue in FY 2016. That's up from $700M in 2015, a 4.6X growth in just one year. Assuming that the Credit Suisse team is right with their ballpark estimate, Instagram needs to grow its annual revenue by 60% to hit an annual run rate of $5B+, which looks likely, given the current growth trend of Instagram ad revenues.
Facebook Valuations Are Now Looking Attractive
Facebook stock isn't exactly known to be a value buy, but yes, Facebook stock is now looking attractive even going by traditional valuation metrics. Well, before you jump to conclusions, let us explain. While the current PE multiple of FB stock, at 38, doesn't really justify Facebook as a value play, we need to look at the forward multiples. Forward multiples reflect the future to some extent, and things get interesting if you look at FB stock from this perspective.
The current Wall Street consensus expects Facebook to report Non-GAAP earnings of $6.69 in FY 2018, implying a near 26% YoY growth in earnings over the next 2 years. FB stock closed the last trading session at a price of $133.53 per share. In other words, the stock is trading at just under 20X its FY2018 estimates. Well, if that's not attractive, then we don't know what is. A PEG (PE/Growth) ratio of 0.77 would qualify as a value play, anyway you look at it. A PEG ratio of lower than 1 is usually considered attractive/undervalued, while a PEG of greater than 1 is usually a relatively higher risk play. Using a benchmark PEG ratio of 1 to value Facebook stock, an ideal target price for Facebook stock would be $174, which is 26X the FY 2018 earnings consensus. A target price of $174 implies a 30% upside from the last closing price, which makes Facebook an attractive buy at the current price levels.
Putting It All Together
Facebook stock has been on a tear in 2017. Already up 16% in the year-to-date, FB stock looks set for higher grounds, driven by the growth in mobile ad revenues and the emergence of Instagram as a major revenue source. The current price levels, at 20X Fy 2018 estimates, provide long-term investors an attractive entry point into Facebook stock. Hence, long-term investors seeking growth names should continue to add Facebook to their holdings at the current price levels.
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