The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
On Thursday, Facebook (NASDAQ:FB) introduced and then launched Video on Instagram, which allows users to record 15-second videos and apply 13 filters to adjust the appearance of the content. Video on Instagram will compete with a number of other video apps, including Twitter’s Vine, none of which has come close to replicating Instagram’s popularity for photos. According to Onavo Insights, the most popular video sharing app on iPhones in May was Vine, which had a reach of just over 10 percent (the rest of the competition had under 1 percent each), well below Instagram’s reach for photos on iPhones of almost 36 percent. As of Thursday, Instagram has 130 million monthly users, with 16 billion photos shared on the app so far, and 1 billion likes generated every day.
Video on Instagram has a number of differentiating features that should appeal to users. As mentioned previously, users will be able to record up to 15 seconds of video, compared to Vine’s 6 seconds, and apply 13 filters to adjust each video’s appearance, whereas Vine has no filters. In addition, multiple clips can be recorded within one video, with the last clip easily deleted. Users can pick the cover frame from within the video, add a quote, add the video to the photo map, name a location, and share to email, Facebook, foursquare, Tumblr, or Twitter. Videos play once, and do not loop, unlike on Vine. Video on Instagram also enables the use of hashtags. The app is already available to both iOS and Android users.
One of the key advantages of using Video on Instagram is a feature called Cinema, which enables cinematic stabilization. Videos have the appearance of being recorded from a stable vantage point as opposed to one that is quickly moving around, eliminating wobbling. We believe the presence of Cinema significantly improves video quality and should further differentiate Video on Instagram from its competition.
We believe Facebook could eventually introduce interstitial ads on Video on Instagram in order to improve the app’s monetization without alienating a large percentage of viewers. We believe many Internet and mobile device users have become accustomed to seeing ads before, during, or after accessing video content. Therefore, showing ads tied to video content is likely a more natural fit than showing ads tied to photos. We note that Instagram does not currently show advertisements; however, we expect the app to eventually follow the same course as Facebook itself and allow them once stickiness has been maximized by a slew of product updates.
Investment Thesis: In our view, Facebook’s valuation should be based on its earnings potential. Unfortunately, Facebook’s earnings in 2012 do not necessarily demonstrate that potential, and given management’s decision to accelerate investment in future growth, it is not likely that we will see a reacceleration of earnings growth in 2013. We believe that it will be at least 2015 before Facebook generates more than $1.00 in EPS. Facebook should be valued on the revenue potential of its user base, which is growing as the company successfully monetizes its mobile users, and will grow further as Facebook implements new products. We think that ultimately, Facebook users will generate ARPU of $10 – 15 annually, driving revenues up by 100 – 200 percent, and we believe that the company can adjust its cost structure to deliver very high margins on those revenues.
Maintaining our OUTPERFORM rating and our price target of $35. Our price target reflects a value of $60 per MAU at Facebook’s peak MAU level with a conservative monetization assumption of $1 per MAU per month for five years.
Risks to the attainment of our share price target include increased competition, changes in advertiser or consumer preferences, mobile advertising growth, changes to the terms or economics of its agreements with partners, and legal and regulatory risks.
Michael Pachter is an analyst at Wedbush Securities.