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How Long Will It Take Facebook Inc. To Recoup $2 Billion On Oculus?

By Leo Sun - Apr 1, 2016 at 8:19AM

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Will the social network’s $2 billion bet on virtual reality pay off?

Facebook's (META -0.76%) Oculus VR recently started shipping its first batch of Oculus Rift virtual reality headsets. The device is widely expected to be a bellwether for the fledgling VR market, which tech M&A advisory firm Digi-Capital expects to grow from nearly nothing today to a $30 billion market by 2020. That's why Facebook was willing to pay $2 billion ($1.6 billion in stock and the rest in cash) for Oculus nearly two years ago.

Source: Oculus VR.

But for Facebook investors, Oculus Rift sales probably won't generate much meaningful revenue over the next few quarters. Piper Jaffray estimated last year that the Oculus Rift would account for just 3.6 million of the 12.2 million VR headsets shipped in 2016. Based on its $600 launch price, that would translate to $2.16 billion in revenue -- roughly 8% of its projected sales for 2016.

After factoring in material costs and other expenses, how long could it actually take Facebook to recoup the $2 billion it spent on Oculus?

How much does the Oculus cost to make?
Since the commercial version of the Oculus Rift just shipped, there aren't any detailed teardowns regarding material costs as of this writing. But a recent Goldman Sachs forecast claims that the Oculus Rift has a BOM of $500. Assuming that estimate is accurate, the addition of R&D and marketing expenses means that Facebook would barely break even on each headset sale.

That wouldn't be surprising, considering that modern gaming consoles are sold on the same paper-thin margins. An early IHS teardown of Microsoft's (MSFT 1.07%) Xbox One, which launched at $499, revealed that the console had a combined BOM and manufacturing cost of $471. The firm also reported that Sony's (SONY -0.11%) PS4, which launched at $399, cost $381 to make. The addition of R&D and marketing expenses meant that both consoles were probably sold at a loss.

It's all about the software
Microsoft and Sony can afford to sell their consoles at thin margins or losses because they can recoup the revenue through game sales. Both companies generally receive a royalty of about 12% for each game sold for their consoles. Market tracking site VGChartz reports that average Xbox One and PS4 owners have each bought about six games so far. Assuming that each game costs $60, Microsoft and Sony will have made an extra $42 off each customer -- a number that will keep rising as both consoles mature.

Facebook is likely pursuing a similar strategy for Oculus. Last year, it launched a dedicated VR app and media store called Oculus Home, which also works with Samsung's (NASDAQOTH: SSNLF) $99 Gear VR headset. Piper Jaffray estimates that Samsung will sell 5 million Gear VRs this year, which means that 8.6 million consumers' eyes could be glued to Oculus Home apps by the end of the year.

Oculus Home. Source: Oculus VR.

Facebook takes a 30% cut from Oculus app sales, which is in line with the standard cut for mobile apps. The initial batch of Oculus games cost between $10 and $60. If each Oculus Rift owner buys about six games by the end of the year for an average price of $30, that would translate to an extra $54 per customer -- which would make each headset sale profitable, with nearly $200 million in high-margin revenue based on estimated Rift sales alone. The addition of cheaper mobile-based games on the Gear VR could add a few million to that total.

But it's all speculation for now
Research firm Tractica recently forecast that worldwide sales of VR headsets could surge past 200 million units by 2020. Assuming that the Oculus Rift accounts for a third of those shipments while its software ecosystem keeps growing, it's certainly possible for Facebook to recoup the $2 billion it spent on Oculus within the next decade.

But during last quarter's conference call (as transcribed by Thomson Reuters), CFO Dave Wehner warned that the impact of Oculus Rift shipments would be "immaterial" to its total expenses and financials for the year, and that it was still too "early to be talking about large volume" shipments. Wehner also noted that the Rift comes "early in the evolution of VR," strongly suggesting that even Facebook doesn't know how well the headset will sell.

What investors should focus on
Facebook likes to buy companies like Instagram, WhatsApp, and Oculus, and build up their user bases before monetizing them. But as we've seen with Instagram, its monetization strategies pay off once users are fenced in. It's unclear if Facebook can do the same for Oculus, but if it does, it will have established an enviable first-mover's position in the growing VR market. But for now, investors should focus on the evolution of Facebook's core ad business instead of speculative plays like Oculus.

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