A Look at Instagram's Revenue Potential


Source: Instagram.

Instagram is certainly key to Facebook's (NASDAQ: FB  ) strategy. That's why I was out to keep tabs on the photo-sharing app during the company's second-quarter earnings call. Unfortunately, I was greeted by nothing but ambiguity and hopes. Even so, it's time I make some quantitative estimates, just so we can start putting a figure on this segment. What-if estimates help me keep my expectations in check.

The update
First, what exactly did Facebook say about Instagram when it reported second-quarter results?

Instagram now boasts 130-million monthly active users. Comparatively, Facebook has about 1,155-million monthly active users, and LinkedIn had 218-million members when it reported earnings about three months ago. One-hundred-and-thirty million is a big gain over the 22-million users the app had when Facebook acquired the service less than a year ago. Even sequentially, the service grew substantially, up from 100 million monthly active users last quarter.

Instagram video? It's off to a great start, Zuckerberg explained. Users are uploading "hours of video to Instagram every minute."

Brace yourself for ambiguity at its finest. Management is seeing "impressive engagement" and "unprecedented growth" (likely implying the service is still growing faster than Facebook did when it was Instagram's size).

Zuckerman on Facebook's plans to monetize the service:

Kevin has always been clear that we're building Instagram to be a business and that we expect that over time we're going to generate a lot of profit from it and probably through advertising... When the right time comes, then we'll think about doing advertising... And I think that's going to be a really big opportunity.

So there you have it... Instagram is growing fast, and it should profitably contribute to the bottom line at some point in the future. Thanks for the excellent update Facebook.

Revenue potential
Can 130 million (and growing) photo-loving users meaningfully contribute to Facebook's top line? I think so. Here's a ballpark estimate of how Instagram could move the needle.

Assumptions:

  • Instagram members grow 10%-15% sequentially for the next four quarters, to about 200-million monthly active users one year from now.
  • Instagram introduces ad products for marketers.
  • Instagram allows members to pay for an ad-free experience.
  • Though not a perfect comparison, I'll use Pandora's advertising revenue per member, and its ad-free subscription revenue per paying member as estimates for Instagram's revenue.

Based on these assumptions, 200-million monthly active users could generate $1.2 billion in annual advertising revenue for Facebook ($6 per user). Furthermore, Instagram could potentially collect $112 million from members who opt for an ad-free experience. That's an additional $1.212 billion added to the top line -- a small, yet still meaningful, amount compared to Facebook's trailing 12-month revenue of just over $6 billion.

Why Instagram matters
Clearly, Instagram can meaningfully contribute to Facebook's bottom line over time. My estimates are likely to be far from reality, but the ballpark figure ads some perspective to Instagram's potential.

Of course, Facebook's purchase of Instagram was just as much a defensive move and an effort to create future synergies as it was a move to lock in future earnings potential. Still, exercises like this are useful when evaluating Facebook. A bet on Facebook is a bet on expansion into new categories. Advertising alone won't promote Facebook into its lofty valuation. Visionary founder and CEO Mark Zuckerberg is going to need to create synergies and new streams of revenue to meet shareholders' expectations.

When you're thinking about Facebook's future, don't stop at advertising revenue for the company's popular social network. How far can Facebook take Instagram? What other new areas might the company explore?

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