Facebook Set to Buy Oculus - Analyst Blog

Facebook Inc. FB is on an acquisition spree. The social network company recently announced the acquisition of Oculus VR for $2.0 billion, just a month after it bought WhatsApp for a whopping $19.0 billion.

The purchase price includes $400.0 million in cash and 23.1 million shares of Facebook stock. It also includes $300.0 million as earn-out in cash and stock based on the achievement of certain milestones. The acquisition is expected to close in the second quarter of fiscal 2014.

Oculus develops virtual reality headset, the Oculus Rift, and provides software development kit for building applications for which it has already received more than 75K orders. Although the technology is currently limited to gaming, Facebook plans to extend it to new industries such as communications, media and entertainment and education.

Facebook's surprising move into the emerging virtual reality market is projected to bear fruit over the next 5 to 10 years, which is a bold step in our view. If Oculus technology succeeds in gaining mass adoption, it will help Facebook dominate the virtual reality market, going forward.

Facebook will enjoy a first mover's advantage much similar to what Apple AAPL enjoyed in the smartphone market during 2007-2012. Moreover, the company's strategy of acquiring next-generation technology strengthens its software developer talent base. This is significant as Facebook expects to focus on delivering Oculus technology as software and services rather than hardware.

However, Facebook's frantic pace of acquisitions and their long-term growth nature are major concerns for investors. Per Bloomberg, to-date the decade-old company has spent approximately $21.0 billion on 40 acquisitions. At the end of 2013, Facebook had cash and cash equivalents of $11.4 billion.

In order to calm investors' nerves, we believe Facebook needs to maintain its ad revenue growth momentum, particularly in the mobile segment over the next couple of years. However, this may become difficult as the company continues to face intensifying competition from Google GOOG and Twitter TWTR in the ad market.   

Moreover, Facebook will face competition from Sony's Project Morpheus in the virtual reality market over the long term. Oculus rift is also expected to face severe competition from wearable devices developed by Google, Apple, Samsung and Intel.

Nevertheless, Facebook's growing mobile user base (more than 1 billion), Instagram's increasing popularity (200 million users) and the new initiatives such as Internet.org will continue to boost Facebook's share price in the near term.

Currently, Facebook has a Zacks Rank #2 (Buy).