Facebook hits Snap, Twice

Facebook, Inc. (NASDAQ:FB) generated buzz last week with several new features across its social media platforms, two of which will likely affect soon-to-be-public rival Snap, Inc. (NYSE:SNAP), a point we'll be expanding on in our coverage of Snap's IPO. These moves go beyond "keeping up" with Snap and demonstrate that FB has a much broader array of tools to target the social market.

The first was a launch of "statuses" on SMS application WhatsApp, which include text/pictures that will expire after 24 hours and will allow users to overlay drawing, captions, and emojis over images - just like on Snapchat.

FB also announced the ability to upload multiple photos and videos into a single Instagram post, which, while not an exact copy of Snapchat's story feature, will similarly allow users to showcase a handful of pictures/videos related to one social event, plus the added benefit of receiving likes and comments. As of Dec. 31, 2016, WhatsApp boasted 1.2 billion monthly active users (+20% y/y growth) that send 50 billion messages a day.

On FB's Messenger platform, the mobile version of its Facebook instant messaging feature, chat windows will soon include AI-driven commerce buttons that facilitate social-event-related purchasing including food, transportation, and entertainment. Earlier commerce-related pushes include FB's March 2015 initiative to allow money transfers through Messenger, as well as its October 2016 launch of Craigslist alternative Facebook Marketplace.

Worth noting is that FB built its own infrastructure to manage credit/debit card information, in contrast to Snap, which partnered with Square to handle money transfers. Messenger eclipsed 1 billion monthly active users last July and FB continues to add to the platform, as it launched picture filters, games, and group video chat in December. As of FB's Feb. 1, 2017 FY16 earnings release, over 400 million people were using Messenger's voice and video chat features.

Bottom Line: FB continues to leverage its strong portfolio of social media offerings to drive user engagement and to encroach on others' territory. FB is also continuing to find new ways to monetize its accumulation of data and to drive commerce through its own platforms, resulting in increasing operational leverage. For example, FB and KLM Royal Dutch Airlines (KLMR) kicked off a program in early 2016 that allows Messenger to be used as a customer service tool, showing everything from boarding passes to in-flight chat with KLM representatives.

More importantly, these moves, demonstrating FB's ability to remain agile and out-dev Snap, support our thesis that FB is somewhat immune to significant threat from about-to-IPO Snap. We do not see Snap's continued growth or IPO-infused bank account as a threat to FB. The one caveat here is the growing complexity of FB's array of applications, which (if FB is not careful to continually simplify and clarify) could result in user fatigue and negatively impact advertising revenue in out years.

Facebook Plays Ball with MLB

FB is reportedly in talks to stream one MLB game per week during the 2017 season, continuing its push into live video streaming. This news comes a little over a week after FB announced a deal with Univision to stream 46 Mexican soccer matches (Liga MX) in 2017.

Bottom Line: When compared to other social sites' attempts at streaming live events, such as Twitter (NYSE:TWTR), we believe FB has a clear advantage. Its existing live video offerings have already demonstrated the ability to pull both personal and marketing activity away from TWTR (and Periscope). With its strong push into video advertising, and significant infrastructure spend on tap for 2017, we view this as having the potential to increase advertising ROI for FB's marketing clients if it is successful.

Facebook wishes Zenimax's VR litigation was virtual

On the VR (virtual reality) front, FB's Oculus is fending off a potential blow by game maker Zenimax, which recently won a $500m verdict against Oculus, as Zenimax is asking the court for all affected software to be banned from future game development.

In the original lawsuit, Zenimax alleged that Oculus CTO John Carmack, one of the lead architects of the Oculus Rift headset, used company-secret code created at Zenimax-owned id Software - a company founded by Carmack. While Oculus was not found guilty of any criminal wrongdoing, Zenimax was awarded a $500m payout, consisting of the following (source: Businessinsider.com):

• $200 million for violating the non-disclosure agreement Oculus co-founder Palmer Luckey signed with Zenimax;
• $50 million for copyright infringement, and another $50 million for false designation;
• $150m from former Oculus CEO Brendan Iribe to Zenimax million for false designation; and
• $50m from Oculus co-founder Palmer Luckey to Zenimax for false designation.

Zenimax is now demanding that any games using the software be barred from use in future Oculus products, which would be a non-negligible setback. Industry research firm IDC projects the total VR/AR market to jump from $5.2 billion in 2016 to over $162 billion in 2020, a CAGR of over 36%.

Bottom Line: The Oculus litigation highlights an ever-present risk where legal issues are bound to emerge due to the pervasiveness of collaboration, code-sharing, and fluid employment in software development. It also demonstrates the murkiness of copyright law with regard to software and IP (intellectual property). Lines in the sand will continue to be drawn and disputes will likely be messy.

Despite the disappointing news, we don't believe any settlement amount - and a settlement is increasingly likely - will materially affect FB. However, should the injunction be granted, it could significantly alter the growth trajectory for Oculus products which, we believe, will become an increasingly important part of the larger FB ecosystem within the next few years.

While we are watching the Zenimax litigation closely, we are not adjusting our FB investment thesis and we reiterate our conviction in our long position. As of 27 Feb 2017, FB is trading at a 52-week high of $135.44 (+25.5% since 26 Feb 2016), giving it a market cap of $359.81b.