Facebook’s Opportunity

on April 28, 2016

Facebook reported earnings for the first quarter of 2016 on Wednesday and they bucked what’s been the trend for most of the other big tech companies so far this earnings season. The company reported phenomenal year on year growth in users, revenues, and profits, and seems to be facing few of the headwinds its competitors and counterparts are facing. Why is Facebook doing so well and where does it go from here?

Note: the charts in this post come from the quarterly deck I do on Facebook (as well as lots of other tech companies) as part of my Quarterly Decks service, which you can read more about here.

User growth multiplied by ARPU growth

Facebook reported yet another quarter of strong user growth, in marked contrast to Twitter, which has been eking out only very modest growth recently. In fact over the past year, Facebook’s monthly active users grew by roughly two-thirds the size of Twitter’s entire base. This wasn’t a one-off – Facebook has grown by over 150 million users year on year for the past four years at least and growth has actually accelerated recently:Facebook y on y MAU growth

Predictably, the strongest growth has been in the least mature markets – Asia and Facebook’s “Rest of World” geographic segments lead the charge, with over 75 million new users each over the past year, while North America and Europe added fewer users (but still grew decently). That reemphasizes the importance of Facebook’s efforts to grow usage in those emerging markets and, hence, projects like Free Basics (recently shut down in India) and its other connectivity projects. So far, though, it seems to be doing just fine in these countries.

Average revenue per user is also growing strongly across the board, led by the US and Canada, where annual ARPU is approaching $50. Other regions have far lower ARPU – the rest of the world combined has an annual ARPU of just $7:

Screenshot 2016-04-27 17.22.34

That overall ARPU growth multiplied by the user growth is driving phenomenal overall revenue growth. And, because that growth requires a much more modest increase in costs, it’s also driving margin expansion. Revenue grew by 52% year on year for the second quarter in a row and operating margin was up 11 points year on year. Just as a reminder, that revenue is almost all coming from ads at this point – the FarmVille era is well and truly over at this point and payments are a tiny fraction of total revenues for Facebook today.

The mysterious role of Instagram

One of the hardest things to get at in Facebook’s results is the role of Instagram. The app has been serving up ads for some time now and management has been talking up the benefits in general terms for several quarters. But it doesn’t break out metrics other than monthly active users (400 million at last count). In addition, Instagram users are excluded from the MAU count Facebook reports and on which it bases its ARPU calculations, even though Instagram revenue is included in ARPU. As such, there’s a little misdirection going on in that Facebook is including Instagram in the numerator but not the denominator here. There is, to be sure, a good chance many Instagram users are also Facebook users and so there’s not too much double counting, but I do wonder how much of the growth in ARPU is from Facebook monetizing Instagram better and how much comes from the core product. It almost certainly has a bigger impact on those rapidly growing (and large) US and Canada numbers than in other regions, but it’s likely being felt in additional markets too.

The Messenger and WhatsApp opportunity

That all brings us to the next point. Facebook hasn’t officially turned on the monetization spigot for Messenger or WhatsApp yet. At the F8 developer conference recently, Facebook outlined its vision for turning these additional products (including Instagram) from products into platforms by opening up functionality to developers. But there’s also an opportunity to turn them into real moneymakers as it already has both the core Facebook experience and Instagram. It’s being very careful about that, as it was with the initial mobile ad experience on Facebook itself. Facebook has the additional challenge of getting around WhatsApp founder Jan Koum’s antipathy to ads, but I’ve no doubt it will find a way in time. I’ve written previously about some of the ways it looks to do this and I think these opportunities have significant additional growth potential if they’re done right. Given how fast Facebook is already growing, once it decides to make the switch on monetizing these products, things might even accelerate, which is an impressive feat given the scale of the business. Those opportunities are largely tied up in increasing the ways in which businesses communicate with their customers, and ultimately building a commerce platform. That could raise ARPU even further, both for the core Facebook experience and for these offshoots and acquired platforms.

Headwinds

As I mentioned, Facebook’s competitors and counterparts among big tech companies seem to be facing a variety of headwinds – Apple, the increasing maturity of its three major product lines; Google, the shift to mobile ads (where Facebook is a much bigger force); Microsoft, the decline of the PC and traditional productivity software; Amazon, the challenge of competing in new markets like China and India where local competitors are much stronger, and so on. All of the above are also dealing with currency movements which devalue the contributions of their non-US businesses. What headwinds does Facebook face? The recent stories about a decline in the more personal sort of content sharing and the more persistent stories about teenagers moving to other platforms are certainly candidates. Neither of these appears to be denting Facebook’s growth so far – engagement seems to be rising, not falling and, though users may be sharing less personal material, they’re sharing more of other types of content including video and news articles, which make for better ad material anyway. But these are perennial threats and can’t be entirely dismissed.

From a perspective of internal threats to success, Facebook is placing some biggish bets on future projects like virtual reality (through Oculus) and research and development into new forms of connectivity, both projects outside its core business and therefore both potential distractions and financial sinkholes. But the scope of these efforts seems to be modest in the context of Facebook’s overall business and its margins aren’t suffering yet. Government action on Free Basics, as we’ve already seen in India, is another possible threat, but a modest one at this point and one few other governments seem willing to take on for now.

Perhaps the biggest threat of all is that platform owners like Apple and Google end up owning the next round of devices and platforms in the same way they have smartphones despite Facebook’s VR investments, and steadily squeeze out third parties they perceive as a threat. Facebook seems aware of this possibility and has invested not just in VR as a potential future interface but also an increasingly OS-like presence on smartphones but, so far, this is a theoretical threat at most and Facebook continues to dominate the time people actually spend on their phones. For now at least, Facebook looks set to continue to buck the market trend.