Facebook investors are facing 3 big questions

Facebook oculus riftTwitch/Oculus VROculus Virtual Reality

Facebook stock has been a huge winner in the current bull market. The stock is up 21.5% this year and 439% since bottoming out at the beginning of 2013.

In a report circulated on March 17, a team of analysts at UBS led by Eric J. Sheridan suggest the party can keep going as long as Facebook can answer three major questions:

1) Can Facebook grow its advertising business by at least a 25% annual rate between 2016 and 2019?

2) How will Facebook’s emerging businesses contribute to long-term growth?

3) Can Facebook maintain “flattish” margins in the next 2-3 years?

Video and ad growth

The bank believes the answer to the first question is yes. The analysts think Facebook can continue to grow their ad revenue at not just 25%, but around 28% per year through 2019. According to UBS, the two big driving factors behind Facebook’s advertising growth will be Instagram, growing at a projected rate of about 47%, and mobile, in particular, mobile-video advertising. Facebook is seen as the leader in mobile video, and that is huge according to UBS.

The company is planning to strengthen its lead in video. During the Q4 2016 Facebook earnings call CEO Mark Zuckerberg noted:

“We’re looking for ways to grow the ecosystem of video content on Facebook. We want people to think of Facebook as a place for interesting and relevant video content from professional creators as well as their friends. Last year we started to invest in more original video content to help seed the ecosystem, and we’re planning to do more in 2017.”

The future of messaging and VR

On the second question, UBS is bullish on Facebook’s emerging businesses like Messenger, WhatsApp, and Oculus, but sees them more as long-term investments that should yield substantial returns if properly managed.

UBS agrees with Facebook that the best way to monetise Messenger and WhatsApp is through business applications, rather than traditional advertising.

On the same earnings call Zuckerberg added:

“In terms of transactions, one of the big things that we see happening in messaging long term is that it’s a great channel for people to interact with a business one-on-one and either do transactions in a private space or get support, or for businesses to reach out with very personally tailored messages and have an ongoing engagement with a person. So that’s something that we’re very excited about building. And that is going to be the business that we hope to build on Messenger and WhatsApp over time. So we’re looking forward to that.”

Additionally, virtual reality, mainly in the form of building out the company’s 2014 acquisition of Oculus, is another long-term play for Facebook according to CEO Mark Zuckerberg:

“But I don’t think that there is really a strategy to pull this in from 10 years to 5, I just think it’s going to be a 10-year thing. The analogy that I always use is the first smartphones came out in 2003 […] and it took 10 years to get to 1 billion units. […] if we can be on a similar trajectory of anywhere near 10 years for VR and AR, then I would feel very good about that, and I feel like we’re making the right bets now to plant the seeds for that. ”

Facebook plans to sell all of their Oculus VR hardware at cost. Profits are expected to come from royalties paid by game and app developers who wish to sell their products on the Oculus platform. Facebook also intends to eventually integrate social media into the VR platform. Players will be able to use old-school Facebook in addition to new virtual reality meeting rooms where friends can “meet up” in a virtual lounge to watch videos, listen to music, and play social games.

The near term

The third question posed by UBS was on margins over the next few years. Facebook has done a very good job of setting guidance that is neither too conservative nor too hopeful, keeping investors happy come earnings time.

For 2017, Facebook provided guidance suggesting considerable investment increases that could cut into margins. However, UBS believes that Facebook may be overly conservative on these numbers’ impact on profits, considering Facebook would have to hire new employees at nearly double the rate of the last two years. Therefore, UBS is bullish on margins and thinks that Facebook is being modest in their guidance.

Overall, UBS is very positive on the future of Facebook. The bank has a $US165.00 price target on the stock, 18% higher than the March 17 closing price of $139.82.

To get the most recent real-time Facebook quote, click here.

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