EXPERT ANALYSIS of Facebook’s Face.com Acquisition

On Monday, Face.com, an Israeli developer of facial recognition technology, announced that it had been acquired by Facebook (NASDAQ:FB). Face.com reportedly already powers Facebook Photos’ facial recognition functionality, and the acquisition is being viewed as bringing the Face.com team and their technologies in-house. According to CNET, Face.com offers APIs for thirdparty developers to incorporate Face.com’s facial recognition software into their apps. In addition, Face.com offers two Facebook apps, Photo Finder, which helps users find untagged photos, and Photo Tagger, which automatically tags photos on Facebook. Face.com also developed KLIK, an app requiring a Facebook account and an iOS device that allows users to quickly tag Facebook friends.

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Although terms were not disclosed, Face.com was reportedly acquired for $80 – 100 million, with the deal expected to close in the next few weeks. According to TechCrunch, Face.com’s specialty is mobile facial recognition, and the acquisition should allow Facebook users to upload a photo, receive recommendations for tags, and confirm the tags in a simple and efficient process. In our view, this process would dramatically increase the number of mobile tags, and drive further engagement on Facebook. The Facebook acquisition of Face.com follows the recent purchase of Instagram and the introduction of Facebook Camera.

We view the Face.com acquisition as being in-line with Facebook’s strategy to strengthen its mobile presence. Facebook’s worldwide mobile monthly active users (MAUs) grew 69% to 488 million at March 31, 2012 from 288 million at March 31, 2011, a much faster growth rate than for total worldwide MAUs, which grew 33% to 901 million from 680 million over the same time period. However, Facebook does not currently generate any meaningful revenue from users that access its website through mobile apps or through its mobile website. In March 2012, it began to include advertisers’ sponsored stories in mobile News Feeds. In our view, mobile revenue growth will a key driver of the company’s overall growth as users supplement their usage on PCs with usage on phones, tablets, and other mobile devices. Location features and the Face.com acquisition will likely allow Facebook to drive mobile engagement meaningfully in the near-term, with potential incremental revenue generation opportunities arising longer-term.

Despite Facebook’s historical focus on users over revenue, a limited mobile advertising presence so far, and some hesitation from high-profile advertisers, we remain convinced that rapid revenue growth for the company will occur. As Facebook continues to enhance the user experience through transactions such as the Face.com acquisition, we expect three things to happen:  first, we think that a better experience will lead to a greater number of users; second, we think that a better experience will lead to higher levels of engagement; and third, we think that a greater user base that spends even more time than the current user base will be an irresistible target for advertisers.

Maintaining our OUTPERFORM rating and 12-month price target of $44, which implies a 22x multiple on our hypothetical 2015 EPS figure of $2.00. We think that our price target is warranted due to Facebook’s huge upside potential for revenue and earnings growth.

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 Morgan.

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