WALL STREET: Sterne Agee’s Arvind Bhatia Bullish On Instagram Advertising

By David Cohen 

WallStreetSubwaySignThe announcement by Instagram Thursday that it would begin incorporating advertising into its feed prompted Sterne Agee Analyst Arvind Bhatia to raise his target price for shares of Instagram parent Facebook to $58 apiece from $50.

Bhatia also raised his estimates for the following:

  • Fiscal-year 2014 revenue: $9.5 billion, from $9.1 billion.
  • FY 2014 EBITDA (earnings before interest, taxes, debt, and amortization): $5.3 billion, from $5.1 billion.
  • FY 2014 earnings per share: $1.04, from $0.99.
  • FY 2015 revenue: $12.2 billion, from $11 billion.
  • FY 2015 EBITDA: $6.8 billion, from $6.3 billion.
  • FY 2015 EPS: $1.37, from $1.23.

He wrote of the impact of advertising on Instagram:

In a blog post last night, Instagram announced that it will begin to roll out ads in the U.S. in the next two months. With 150 million monthly active users worldwide, up 400 percent since early last year, we think Instagram is now well-positioned to begin monetization.

We expect a slow rollout of ads initially (2014) and acceleration later (2015 and beyond). Ads are expected to be rolled out by year-end in the U.S., where we estimate that there are about 50 million to 60 million MAUs (40 percent of the worldwide user base). We expect the international rollout will likely be sometime in the first half of 2014.

So, the obvious question is: What’s the revenue potential for Instagram? First, we note that Instagram will allow both photo and video ads, which is important because video ads are more lucrative. We note that Facebook’s U.S./Canada advertising ARPU (average revenue per user) in the TTM (trailing 12 months) was more than $12, up more than 20% percent year-over-year. We think Instagram ads could ultimately command a premium to Facebook ads, although that will likely take a while.

Assuming a U.S. ARPU of $4 for Instagram over the next three years and average U.S. MAUs of 100 million by then would suggest revenue potential of $400 million in the U.S. in the next three years and much higher longer-term. Europe and the rest of the world could add another $400 million over the next three to four years. Net, we estimate that Instagram could generate $800 million in revenue in the next three to four years. We note that Twitter, with roughly 50 million MAUs in the U.S., is on a run-rate to generate $350 million to $400 million in the U.S. this year.

Readers: What impact do you think the introduction of ads on Instagram will have on Facebook’s bottom line?

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