Facebook Inc (NASDAQ:FB) caught some flak a month before its 2012 IPO when it agreed to buy 18-month-old Instagram for $1 billion in cash and stock. Many couldn’t believe that FB would spend that much money for a startup with only 30 million users and no revenue stream.
In 2015, investors and industry experts have changed their tune. Instagram is valued well over $30 billion and is the driving force behind why you should have FB stock in your portfolio.
On Feb. 18, Cowen Group analyst John Blackledge gave an estimated valuation of Instagram at $33 billion — and that’s in the ballpark of the $35 billion valuation that Citigroup estimated at the end of last year.
The basis for the strong valuation is that Instagram ended 2014 with more than 300 million monthly active users and is forecasted to more than double that number by 2020. What’s even more impressive is that Instagram grew its customer base from 200 million to 300 million since last March.
Both the Cowen Group and Citibank reports pointed out that Instagram is now bigger and growing faster than Twitter. Both reports also noted that Instagram users are more engaged than those using Twitter. Citi stated specifically users are 1.8 times more engaged than those who use Twitter.
The growth and interaction of Instagram has allowed it to garner a great deal of advertiser interest. Advertisers want the attention of all those engaged users — and that’s a wonderful thing for the Facebook bottom-line now and in the future.
The FB Turnaround
To understand why the growth of Instagram is good for FB stock, you need to understand how Facebook makes money.
Facebook stock did not have the greatest start. Within six months of its initial public offering, FB stock had lost half its value and was one of the priciest stocks on the S&P 500.
So what caused the rebound? Facebook revised its advertising platform.
Early in 2013, Facebook came up with a new ingenious and inexpensive advertising format. Unlike search engines, social media companies have to find ways to integrate advertising into your interactions without seeming intrusive. The new format is called “native social ads” where advertising is integrated into the social media experience.
Examples are in-stream ads like the commercials you see before YouTube videos. According to Money Morning e-commerce director Bret Holmes:
“Facebook has integrated in-stream ads to the user experience. Response rates are high and advertisers will always chase the least expensive ad with the best response.”
Facebook can generate an enormous amount of clicks and ad impressions and advertisers are coming aboard. The company highlights that the uptick in its news feed advertisements was the catalyst driving revenue growth. The average price per Facebook ad also went up 173% in 2014.
The number of active advertisers has skyrocketed 33% over the last six months of 2014 to 2 million. Accordingly, 2014 saw that 92% of Facebook’s revenue came from advertising — that’s about $11.5 billion. Total revenue last year was up by $4.6 billion and more than 98% was spurred from an increase in advertising revenue.
As you can see, advertising is the key to Facebook making money.
Instagram Will Propel FB Stock
Last year saw mobile ads take the reins of advertisement growth for Facebook as it accounted for 65% of Facebook’s total advertising revenue — up from 45 percent in 2013.
Expect this number to keep growing. According to Blackledge, when the Cowen Group asked advertisers which social media platform they planned to advertise on for the first time in 2015, Instagram was the most common answer. Expected new advertisers cited Instagram’s fast-growing audience, high engagement and brand affinity, Blackledge said.
Cowen estimates Instagram will help Facebook generate $5.8 billion in revenue by 2020. I believe the perfect storm of millions of more users and the influx of advertising dollars give good reason to be bullish on FB stock.
As of this writing, Jason Jenkins did not hold a position in any of the aforementioned securities.
