When Facebook (NASDAQ:FB) bought Instagram in 2012, the photo-sharing app had about 35 million users. Two-and-a-half years later, it just announced surpassing 300 million active users after adding 100 million new users over the last nine months.
The app's user base is now larger than Twitter's (NYSE:TWTR) and growing much faster. Twitter sports a user base of 284 million monthly active users, and the social network added only 43 million net new users in the first nine months of 2014.
Still, Twitter undoubtedly outperforms Instagram in one key metric: revenue. Does Instagram have the potential to overtake Twitter where it really counts?
A billion-dollar business
When Facebook agreed to purchase Instagram, it valued the business at $1 billion (although the purchase price eventually settled at about $715 million due to stock depreciation). At the time, Instagram did not have a monetization strategy in place, but its visual format provided excellent potential for advertisements.
While Facebook introduced advertisements to Instagram in October 2013, the rollout has been very slow. At this point, Instagram's revenue isn't meaningful enough to even merit a shout-out on Facebook's earnings calls, let alone a spot on the quarterly report.
Comparatively, Twitter is well on its way to completing its first year with $1 billion in revenue. Through the first nine months of the year, the company brought in nearly $924 million in ad sales and data licensing deals.
Twitter's ad business
Both Twitter and Instagram are mobile-first social networks with similarly sized active user bases. But Twitter also has a data licensing business and a mobile ad exchange in MoPub.
While Twitter doesn't break out MoPub revenue, it is relatively small compared to the rest of its business. In the first six months of 2013, the ad exchange's net revenue was just $6.5 million, according to an SEC filing. Even if the company doubled that run rate this year, that's just 2% of Twitter's total revenue through the first nine months.
Twitter, though, does break out its data-licensing business revenue. Through the first nine months of 2014, data licensing accounted for over $100 million in revenue, or about 11% of the company total.At those rates, analysts expect Twitter to bring in approximately $1.2 billion in ad revenue for its flagship platform in 2014 and $2 billion in 2015.
Will Instagram show a positive return on investment in 2015?
While it might be too soon to say Instagram will catch Twitter in ad revenue next year, it holds several advantages that should allow it to generate meaningful revenue in 2015 and eventually overtake the microblogging specialist.
As mentioned, Instagram's user base is growing faster than Twitter's. Additionally, Instagram is much more visually stimulating, which lends itself well to the types of ads most brands are interested in promoting.
Most important, the average Instagram user is on the app an average of 21 minutes per day, according to Facebook. Comparatively, the average Twitter user spends around 7.4 minutes per day on the service. This represents a massive advantage for Instagram to monetize its user base over Twitter.
Additionally, Facebook can leverage its existing ad business on its flagship platform and retarget ads to users on Instagram, and vice versa, increasing their efficacy. That will allow Instagram to increase its ad prices at a faster rate than Twitter can.
It should not be much longer before Instagram starts turning a profit for Facebook. Twitter is on track to produce its first year of positive earnings (on a non-generally accepted accounting principles basis) this year, with $0.03 in earnings per share through the first nine months of the year.
Opening Instagram advertising to more brands in 2015 could boost Facebook earnings per share by a few pennies. The impact on investors would not be too significant considering the company trades for about 40 times next year's expected earnings. (A $0.02 increase in EPS, for example, would translate into an $0.80 increase in stock price.)
The bigger payoff comes down the road when Facebook grows Instagram to 1 billion users, with hundreds of thousands of advertisers.