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Investing  | January 29, 2019

Facebook (FB) is on the cusp of releasing something great, possibly the next big thing.

Earlier this week, there was a report by Business Insider that the company moved a few hundred employees from their FTR facilities to the hands-on product division of AR (augmented reality) glasses facility, which generally happens when a product goes from research and development phase to a final production push phase.

As I review later on, AR and VR (virtual reality) might very well be the future of where technology is headed in the near to medium future. We've seen a push into a lot of different markets with little to no wide-range success in the part few years, as we've seen most companies settle for minor advances like face recognition software, interactive gaming platforms and limited IoT (Internet of Things) advancements but nothing this big that can potentially change the way we interact with out devices and the world around us.

I think that one of the most exciting things about this predicted product launch is the rumor regarding the makeshift of the product, which is expected to look like normal glasses and not like alien spotting ones. This will, in my opinion, be a leading factor for the success of this emerging technology's adoption. In today's day and age all it takes is a viral video and suddenly all the kids in the world want one and 20 minutes later they have them in their hands ready to play with. This also comes well ahead of potential releases of commercial products which are already being used in today's markets.

Facebook is on to something that others have so far tried but failed to grasp the basic marketing and commercial needs and I believe their unique platform will allow them to push this technology into the future.

Facebook Today

Facebook has long been a social media company which generated 99% of its revenues from selling ads on their platform. The social media giant used its exposure to over 2.5B people to create an advertising infrastructure platform rivaled by no other, dwarfing cable news and other advertising platforms which have since lost huge amounts of ad revenue to companies like Facebook and Alphabet's Google (GOOG) (GOOGL).

They've worked to diversify their offerings on the platform to attract more businesses and in my initial article discussing Facebook's future titled Facebook: Oh Snap!, I listed the wide range of products and services it has operational and the ones in the revenue pipeline, indicating that there is no shortage of opportunities for the company in the long run and that a loss of some Facebook.com users is not the end of the world.

It's unclear how much revenue is being generated from its other platforms like Instagram, which has seen exponential growth in 2017 and 2018, even as Facebook's core active use base began to plateau. Ads began showing up on Instagram in the last year or so and the company began offering a revamped service for businesses through their Messenger platform, attracting a massive amount of users to its service over the traditional call-and-wait-3-hours customer service lines. Although a very limited amount of revenue is being generated from this thus far, Facebook's WhatsApp is also gaining international steam and is expected to continue and improve with access to businesses and group working activities with new launches across its platform.

Facebook's CEO was in the news recently about comments he made regarding cross-platform integration which will allow customers or users to move cross platform and use each service within their others to retain more users and create a larger active user base.

The Augmented Reality Market

It has been a while since a brand new technology has come into use in the tech world. I don't dare equate the possibility of AR or VR amounting to the same hype and use as mobile phones did as they came after computers, or tablets to some degree, but I am optimistic on the worldwide and cross-industry applications it will be used for.

According to IDC research, spending in the consumer side of the augmented reality market is expected to reach $53 billion in 2022, growing at a CAGR of 71.6%. AR viewers, which is the segment in which the rumors surrounding Facebook's glasses are categorized in, is set to grow at a CAGR of over 114%, according to the same research.

The main factor in adoption of AR viewers in the consumer market will continue to be the hardware limitations and price. As prices come down and services and offerings continue to rise, we might finally be at the turning point where a several-$100 product with a wide array of ranges is being released and will be used globally. In other markets, Media, Education and Retail, as well as Government and military spending, are expected to collectively reach $53 billion in spending through the same time period although it's unclear if Facebook is going to release a commercial version of their rumored glasses.

Current markets in Healthcare, eCommerce, Architecture and Travel is already being adapted to better help their consumers experience their services and the technology that Facebook's Oculus already has is being used these wide array of industries.

Now granted, Facebook may not be the best going forward, but they'll be the first to adequately meet consumer demand (if the rumors end up being true) and they'll have the most experience in revamping what they've learnt and have, by many accounts, one of the most powerful tools at their disposal with Oculus and their unparalleled marketing platform. (For those of you on the edge of your seats regarding Google Glasses, I discuss it in a few paragraphs.)

Market Share and Revenue Streams

There's little doubt that starting out, Facebook is likely to have a larger market share given their head start over large tech behemoths who are still in the R&D stages and are not yet out into production phase of consumer-friendly products.

When taking a look at competition and what timeframe we should be looking at, I believe the closest competitor is Alphabet's Google with their Google Glasses. By most accounts, their previous launch failed due to a combination of bad marketing and the exclusivity that surrounded them with a hefty price tag of $1,500 for early adopters. Moving forward, however, Alphabet is certain to capitalize on the marketing boom that Facebook will create (if they even do at all) and revamp their products and release new versions of them quite quickly. I still believe that Facebook will have enough of an advantage to overcome real competitive threats but it doesn't look like any other company can really match these two when it comes to marketing and styling budgets in the first few years after the products are released.

Beyond these, there ARE smaller or even better-rounded AR companies out there like Microsoft (MSFT) with their HoloLens, Magic Leap Lightwear, Vuzix Blade AR, and others but most don't seem to have sufficient styling and services options, including their high price tags of well over $500 a pop.

The revenue stream is entirely up to pricing. Like the Google Glasses, if Facebook fails to adequately price the new AR glasses they may end up just holding onto a high market share in an exclusive market with only a few thousand buyers and miss out on the masses. Even if this can produce meaningful revenues for a few years, it's nothing like getting the masses into this new emerging technology.

Spending on these products, as indicated in figures in the latest IDC research, can easily bring in Facebook around $15 billion in annual revenue, assuming a market share of around 20% starting off, a figure which will likely remain stable or decline as competitors introduce more products. On the other hand, as pointed out by the same IDC research report, they may have a revolution-style item which blows past expectations due to superior hardware and pricing power in which case we can see double the amount of predicted sales in the first year alone. I believe that later down the line, coupled with VR glasses and once industries adequately integrate these technologies into their operations, that Facebook can see a revenue stream worth almost a quarter of their advertising platform revenue a few years in.

Valuation

In my previous article I presented then-figures of EPS expectations and concluded that 2018's fair value lies around $210.00 per share based on a 30x earnings multiple of an expected $7.11 per share in earnings. Now, however, future EPS expectations have seen a downward trend, even as 2018 expectations have risen to $7.37.

Earnings for 2019, pending company guidance in a few days, is expected to stay put at $7.37 per share, based on analyst estimates. For 2020, EPS are expected to rise 12.5% to $8.29 and then a further 18.9% to $9.86. I believe, however, that this new market opportunity will add an additional $0.50 per share in earnings starting in 2020 which will justify the continued 30x multiple. This projects the company's fair value around $220.00 per share in 2019, representing a potential increase of 47% from today's price.

For 2020, however, where I believe AR technologies will be producing real revenues and income, a 30x multiple puts the company's fair value at $265.00 per share, producing another 20% return for the year. This is assuming the first aspect of success that I mentioned but may differ greatly if we see a much higher rate of success upon the launch of the new products, like IDC research has noted.

Conclusion

The AR and VR markets are in their infancy, but the way trends are headed it won't be that way for long. Facebook is ramping up R&D and production for new releases through their Oculus company and organic R&D facilities and are set to launch a normal-looking augmented reality glasses set in the coming months as indications they are moving from R&D to production phase surface.

The market as a whole has the opportunity to bring in meaningful revenue if it takes its time catching on over the course of the next few years but also has the opportunity to blast through expectations, as we've seen with other types of technologies. This will come as a welcomed revenue stream add as the company's advertising platform plateaus with a limited number of new users beyond the over 2.5B existing today, relying primarily on price increases.

I believe that meaningful competition from the likes of Alphabet and other private companies mentioned above could arise in the first few months of the release but that Facebook's expertise through Oculus and its talent can retain a competitive advantage and that the company will likely be a market share leader in the first few years after the release of their consumer-friendly products. Furthermore, the company will have a head start in AR glasses allowing them to refocus their R&D resources to virtual reality, which can become an even more powerful tool for enterprise and consumers alike.

Facebook's real advantage here is they are not industrializing the process, they're aiming for the masses with normal-looking glasses and they have an existing advertising platform like no other (perhaps maybe Google, but which failed the Google Glasses) to use for reaching users. I believe that along with their existing cash-machine advertising platform, Instagram's surge in popularity and Messenger and WhatsApp only now beginning to generate revenues, that Facebook is well positioned for the future and will outperform competitors in this space as they diversify their revenue streams.


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