Why Facebook Inc's Profitability Will be Pressured

Facebook's newest acquisitions could give it dominance in future industries, but could hurt profitability in the near term.

Jun 18, 2014 at 12:21PM

Facebook (NASDAQ:FB) seems unstoppable. Last quarter, the company took in $2.5 billion in revenue and $642 million in net income, respectively up 72% and 193% from a year ago. Users keep growing, mobile revenue keeps growing, and its net income margin expanded from 15% to over 25%. With these numbers piling cash on to the balance sheet, Facebook acquired a few companies, notably WhatsApp and Oculus VR.

Unfortunately, both of these new acquisitions are run closer to a profit margin of zero than one in the double digits. Will that slow down Facebook's gangbusters financials?

Whatsapp

A sample WhatsApp chat. Source: WhatsApp.

WhatsApp's breakeven chatter
The messaging service that Facebook acquired for $19 billion in cash and stock charges users $1 per year after a free trial year. WhatsApp co-founder Brian Acton stated that he's happy breaking even, so given the service's 500 million users, it could be that revenue and expenses come in fairly close to that figure. However, expenses may increase under its new owner.

Facebook CEO Mark Zuckerberg said in the company's last earnings call that the "current priority is growth" and "monetization isn't our near-term priority here." As WhatsApp spends more to gain users, the best case is to break even. If you (hypothetically) add in $500 million in expenses and revenue to Facebook's current income statement, its net margin falls about 4 percentage points to 21%.

What about Facebook's other big acquisition?

Oculus

Oculus Rift development kit. Source: Oculus VR.

Oculus
The virtual reality gaming platform that Facebook acquired for $2 billion was far cheaper than WhatsApp, but the eventual development costs could close that gap. Oculus VR CEO Brendan Iribe said it has a "nearly unlimited budget and ability to hire whomever they need." He also said that in order to develop the best virtual reality platform and product, "it was going to take hundreds of millions of dollars in investment -- if not billions of dollars." Even with such heavy investment, Iribe wants to sell the final product for as cheap as possible, near breakeven, to attract the most customers.

The potential drag on Facebook's margin from Oculus' expenses is less clear than WhatsApp's. But it is a definite that it will add some drag to Facebook's seemingly unstoppable growth.

Does that drag even matter?
As Facebook eventually turns to monetizing WhatsApp, whatever drag it has on current financials could easily be made up in future income. If Oculus' product takes off, even selling the hardware near breakeven could easily be made up with high-margin software titles, as with most gaming platforms. 

Additionally, if Facebook can keep up its revenue growth over expenses, the additional expenses of WhatsApp or Oculus will be smaller footnotes to a massive advertising business as they ramp up their own revenue streams. If anything, it seems that if Facebook's new acquisitions cause investors to question its financials, it would open up a nice stock-buying opportunity for any future growth of WhatsApp or Oculus.

Want to buy into the next WhatsApp or Oculus VR?
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Dan Newman has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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