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Investment Thesis

In 2012, Facebook (NASDAQ:FB) acquired Instagram, a photo-sharing app with zero revenues, for ~$700 million. At that time, the deal was questioned by many; however, eight years later, Instagram is one of Facebook’s most valuable and vital properties. According to Bloomberg, an estimate with which my own analysis agrees, Instagram’s ad revenues contributed ~30% (~$20 billion) of Facebook’s total ad revenues ($70 billion) in 2019. Thus, Instagram is one of the primary drivers of free cash flow at Facebook, and as investors in the company, we must continue to monitor the performance of this asset.

In today’s article, I will discuss the reasons behind Instagram’s colossal success and future growth potential. Additionally, we will perform a fair-value estimation exercise to determine the worth of Instagram as a standalone entity, which will thereby serve to highlight the overall value of Facebook in the 2020s.

Instagram User Trends

Since Instagram is a social networking platform, let’s begin our analysis by looking at its most critical aspect: “Number of Users.” Instagram is the sixth-largest social media platform by monthly active users at ~1 billion, as can be seen below.

Source: Digital 2019: Q3 Global Digital Statshot – DataReportal – Global Digital Insights

When Facebook acquired Instagram in 2012, it had roughly 30 million users; whereas today, Instagram is a social media platform with more than a billion users. Here’s a chart that shows the historic monthly active user growth on the platform:

Source: Instagram users worldwide 2023 | Statista

After undergoing exponential growth in users between 2012 and 2019, Instagram’s user base seems to be stagnating in a way similar to Facebook’s core platform, i.e., Facebook. According to Statista, Instagram’s growth rates will continue to decline and come in at just 1.8% in 2023. Hence, we can postulate that Instagram’s user base will reach market saturation in the next few years.

Source: U.S. Instagram user growth 2023 | Statista

The user growth rates are slowing down; however, one must acknowledge the fact that Instagram still has very modest room to grow due to the ever-growing number of social media users.

Instagram Could Further Penetrate Its Total Addressable Market

Source: Digital 2019: Q3 Global Digital Statshot – DataReportal – Global Digital Insights

Instagram’s Growing Influence On Facebook

Facebook does not release its revenues categorically. That is, it only relates statistics such as, the Facebook family of platforms (Facebook, Messenger, Instagram, etc.) made $70 billion in ad sales in 2019; however, we do not have Instagram’s official sales figures from Facebook. According to the aforementioned report from Bloomberg, which corroborates my own analysis of Instagram’s revenues, Instagram made $20 billion in ad sales in 2019.

Considering that Instagram had zero revenues when Facebook acquired the photo-sharing app back in 2012, I think management execution to monetize the platform so far has been sublime. The following chart depicts the growing importance of Instagram to Facebook’s coffers:

Source: Important Instagram stats you need to know for 2020

In 2017, Instagram contributed only ~10% of Facebook’s total ad revenues, but that figure now stands at ~30%. Moreover, Instagram’s share of Facebook’s new ad revenue is close to 70%, which means Instagram’s revenue share is set to go even higher in the future.

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What Makes Instagram So Successful?

Source: Digital 2019: Q3 Global Digital Statshot – DataReportal – Global Digital Insights

The primary driver of Instagram’s success is its unique value proposition to marketers. In layman terms, Instagram provides marketers with an advertising platform that could reach ~850 million people every day. In recent years, several brands have been able to create very successful marketing campaigns (high ROI) by associating with mega Instagram influencers like Kylie Jenner, Kim Kardashian, Dwayne “The Rock” Johnson, Cristiano Ronaldo, etc. Additionally, the results of a survey of Instagram users showed that brands advertising on Instagram create a positive perception of the brand, thereby aiding marketers to enhance the image of their companies.

Source: Digital 2019: Q3 Global Digital Statshot – DataReportal – Global Digital Insights

In today’s day and age, social media is the best way to market products and services to younger audiences (millennials) as they are the most prominent users of platforms like Instagram, Facebook, Twitter (TWTR), Snapchat (SNAP), etc. Thus, social networks such as Instagram are a great place for businesses to find new customers.

Additionally, the results of a survey of Instagram users showed that brands advertising on Instagram created a positive perception of the brand, thereby aiding marketers in enhancing the image of their companies.

Source: Instagram Revenue and Usage Statistics (2020)

Moreover, Instagram has proven itself as an ideal e-commerce marketing platform that can be used as the discovery portion of the sales funnel. According to another survey of Instagram users, eighty-three percent of them said that they discovered new products and services on Instagram.

Source: Important Instagram stats you need to know for 2020

Now, one can think of Instagram as a marketing gold mine, and its miners are popularly known as “Influencers.” What is an influencer? An influencer is someone who can influence the masses. Simply put, if a global superstar like Cristiano Ronaldo endorses a particular brand of shoes, then his Instagram followers are likely to buy those shoes. Some of the most followed “Instagram Influencers” are as follows:

Source: Important Instagram stats you need to know for 2020

Marketers Love The ROI That Instagram Influencers Generate

Source: Influencer Marketing Survey Results: 2019 Industry Benchmarks

According to data from Mediakix, ~80% of marketers find influencer marketing effective, and ~89% say that ROI (Return on Investment) from influencer marketing is comparable or better than other channels of marketing.

Source: Influencer Marketing Survey Results: 2019 Industry Benchmarks

Influencer Marketing Is Itself A Huge Business

According to Business Insider, Instagram is the number one platform for influencer marketing, as ~79% of the brands that pursue these sorts of marketing campaigns tend to choose Instagram.

Moreover, Business Insider Intelligence predicts that brands will spend up to $15 billion on influencer marketing by 2022, almost 2x times the $8 billion spend from 2019. Thus, the opportunity for Instagram in this space is proliferating, and I expect Instagram to contribute an even higher proportion of Facebook’s total revenues (and by extension, free cash flows) in upcoming years.

Source: Influencer Marketing: State of the social media influencer market in 2020

Instagram Stories Are A Great Hit With Users

Insta Stories are small videos that last for 24 hours before getting erased. Since the feature launched in 2016, it has been very popular among Instagram users. The influencers often use the “#Ad” with their Instagram stories to promote various brands in exchange for remuneration. In the future, I believe that Stories will remain the primary driver of Instagram’s revenues as it has been over the last three years.

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Source: Instagram Revenue and Usage Statistics (2020)

The closest external competitor to Instagram Stories is Snapchat. Now, to be fair, Snapchat created and introduced the whole concept of Stories; however, Instagram’s execution was much better, and hence it enjoys ~2.5x times DAUs as compared to Snapchat.

Source: Important Instagram stats you need to know for 2020

Social Purchasing Trend Could Make Instagram’s New Shopping Feature An Alternative Growth Channel For The Platform

In March 2019, Instagram added a shopping and checkout feature that enabled users to purchase items within the Instagram App. Now users could search for products and services, add to a shopping bag, and checkout without leaving the app. The vision here is to make Instagram a personalized digital mall with users being shown products and services they are most likely to buy at the top of their feeds.

On the other end of the spectrum for brands, it’s like opening a storefront in a shopping center where the customers who are most likely to buy from them are automatically directed to their front door: a win-win for users, sellers, and Instagram!

According to a survey of Instagram users, after seeing a product or service on the platform, 79% searched for more information; of those, 65% visited the brand’s website or app, and 46% made a purchase online or offline.

Source: Important Instagram stats you need to know for 2020

For product companies, Selling on Instagram is a valuable feature as it serves as an additional sales channel for brands to attract consumers. Instagram is an incredibly powerful marketing tool, as ~65% of the consumers that see a product on Instagram visit the brand’s website or app. Some fantastic features like product tags and direct call-to-action links within Stories or ads enhance the shopping experience for Instagram users.

What Is Instagram Worth?

To determine a fair value for Instagram, and thereby how much it contributes to Facebook’s overall value, we will employ the L.A. Stevens valuation model. Here’s what it entails:

  1. Traditional discounted cash flow model using free cash flow discounted by our (as shareholders) cost of capital.
  2. Discounted cash flow model including the effects of buybacks.
  3. Normalizing valuation for future growth prospects at the end of the 10 years. Then, using today’s share price and the projected share price at the end of 10 years, we arrive at a CAGR. If this beats the market by enough of a margin, we invest. If not, we wait for a better entry point.

Due to the many questions we’ve gotten on the LASV Model, I’ve decided to just include entire screenshots of most portions of the model. The screenshots should answer most questions, but if you have any still, feel free to ask them in the comments!

Now, let’s check out the results!

Assumptions:

Assumption

Value

Free cash flow per share

$2.09

Free cash flow per share growth rate

12.5%

Terminal growth rate

2%

Years of elevated growth

10

Total years to stimulate

100

Discount Rate (Our “Next Best Alternative”)

9.8%

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Source: L.A. Stevens Valuation Model

As you can see above, Instagram has a present value of ~$70 per share, meaning its current market cap is ~$200 billion.

Now, let’s check out the expected return, which is predicated on the growth of free cash flow per share.

Expected Return

Let’s say we use the net present value from the previous section and assume that Instagram is worth ~200 billion, i.e., Instagram accounts for ~$70 from Facebook’s share price of $235.

To calculate total expected return, we simply grow the above free cash flow per share at our conservative growth rate, then assign a conservative multiple, i.e., 25x or 30x, to it for year ten. This creates a conservative intrinsic value projection by which we determine when and where to deploy our capital.

Check out the results!

Source: L.A. Stevens Valuation Model

Therefore, one can expect Instagram’s value per share to grow from ~$70 to ~$212 at CAGR of ~12% over 10 years.

Of course, we cannot buy Instagram without buying all of the Facebook properties. Therefore, we can use this information to highlight that Instagram could come to be worth more than Facebook’s entire value by 2030, which truly serves to highlight the extent to which Facebook remains undervalued.

Conclusion

Instagram user growth might be slowing down, but its revenues could keep growing for years to come, especially as it creates new innovative outlets for revenue generation, i.e., Instagram shops. And once this growth stagnates entirely sometime during the 2020s, the property should continue to generate extremely high margin, reliable free cash flow.

Now here comes the tricky part.

Ultimately, however, Facebook’s success will hinge on Zuckerberg and Sandberg’s ability to lead this company on an innovative path. That is, they must answer the question: what should we do with the tens of billions of dollars Instagram is generating for us?

For answers to that question, please check out our other articles on the company, which can be found here: Facebook: Vexed By Discounts, So Now You Should Pounce, and Facebook’s Future Is Brighter Than Ever.

Final Takeaway: I rate Facebook a buy at $250 and below.

As always, thanks for reading; remember to follow, and happy investing!

Beating the Market: The Time Is Now

There has never been a more important time in stock market history to buy individual stocks at the heart of secular growth trends. Mature market performers/underperformers and index funds simply will not cut it, as we face a decade during which there is absolutely no guarantee the overall markets will rise. 

This is why the time is now to discover high-quality businesses with aggressive, visionary management, operating at the heart of secular growth trends. 

And these are the stocks that my team and I hunt, discuss, and share with our subscribers!

Disclosure: I am/we are long FB, GOOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.