Why Facebook is a good long-term bet

by Robin Grant in News Google+

Forbes recently carried the following article from me, commenting on Facebook’s IPO and whether their valuation is justified

Forbes

Facebook’s share price may follow an erratic pattern over the next few days and weeks, as did LinkedIn, Groupon, and Zynga after their recent IPOs, but it is a good long-term bet.

With a likely valuation of over $100 billion, at a massive multiple of a hundred times 2011 profit, the company might not look so promising based on its current business model and associated revenue and profit growth. But that’s not what you’d be investing in.

It comes down to these three  factors:

Global dominance. Facebook almost completely dominates social networking globally. It has 900 million monthly active users and 526 million daily active users, numbers that are still growing rapidly (although admittedly user growth has stalled in mature markets like the U.S. and Britain). Perhaps more importantly, the average time people spend on the site is astronomical, with U.S. users logging on average more than seven hours a month, regardless of whether they access by PC or on their phone, as most now do (and again these are numbers that are growing, not declining). Facebook is dominant in all major world markets other than China, Japan, South Korea, and Russia, and based on current growth it’s only a matter of time before that list shortens to China alone.

Strong leadership. MySpace lost its lead because of Rupert Murdoch’s lack of understanding of social media and resulting mismanagement. Mark Zuckerberg, on the other hand, is what you would call a digital native, and he really gets it. His leadership of Facebook’s product development over the last eight years has proven his abilities, as he has constantly evolved and grown the site’s offering. A few hiccups aside, he has consistently made it more and more attractive to both new and existing users with each release.

Not only that, but with the acquisition of companies like Instagram, Glancee, Gowalla, Beluga, Snaptu, Friend.ly, and FriendFeed, Zuckerberg has shown that he has his eye on the ball, and has successfully brought into the Facebook fold external ideas and technologies that keep it ahead of the game (and has taken potential competitors off the field in the process). With Facebook’s dual-class share structure guaranteeing that he’ll remain in control of the reins of power, with a post IPO war chest of around $8 billion, we can only expect both product development and acquisitions to accelerate.

New revenue streams. Facebook currently brings in around $1 billion of revenue a quarter, with about 85% of that from advertising. However, the growth in that revenue is slowing, and this week GM, the U.S.’s third biggest advertiser, pulled the plug on advertising on Facebook (although the automaker is still investing in engaging with its communities on Facebook). So what? Ford has come out publicly in opposition, saying it will continue to invest, and Facebook is continually evolving its advertising offering, just like any other aspect of its product, so expect this growth to continue (although it may continue to slow through saturation). However, there are plenty of other potential revenue streams:

  • Mobile advertising. Facebook is not currently not showing a significant number of ads to its 488-million-strong mobile audience. That fact has been widely reported as a threat to Facebook’s valuation, but actually it  is a massive untapped opportunity not yet showing in the numbers, and you can expect Facebook to address it effectively in the future.
  • Ad network. There have also been some hints in the last couple of weeks of future revenue streams for Facebook. One, indicated by changes to Facebook’s privacy policy, would allow the company to target ads off of Facebook using everything it knows about users, meaning there’s the potential for building a display advertising network using other media owners’ inventory to target ads at users based on their social and interest data—another massive opportunity.
  • Paid-for newsfeed priority. Additionally, Facebook recently ran a small test in New Zealand offering users the chance to pay up to $2 to guarantee that all their friends would see a certain status update. That could be perfect for announcing anything from selling your car, looking for flatmates, or publicizing parties, engagements, weddings, births, etc.
  • App store. Facebook announced a new app store last week, along with a beta paid-for app program. The company has not yet released any details of how it will make its money, but obviously even if this is only a fraction as successful as Apple’s or Amazon’s app stores, there’s billions of dollars to be made.
  • Facebook credits. What’s potentially bigger than all of the above is Facebook credits, a virtual currency now used mainly for social game transactions (which amount to around 15% of Facebook’s current revenue). We’ve already seen credits used successfully by movie studios to rent movies to people on Facebook, and considering both the scale of Facebook’s audience and the time that audience spends on site, this opportunity puts all others in the shade. The recent launch of open graph apps, meaning friends’ actions like “watch,” “listen,” and “read,” have started to show up in people’s news tickers, fuelling massive growth in the use of certain apps, both those of traditional media owners like the Washington Post or the Guardian, which recently reported that Facebook was driving 30% of its traffic, and of new players like Spotify and Socialcam. Think about the potential of buying music from Spotify, renting movies from Netflix of LoveFilm, micro-payments for content from the Washington Post or the Guardian, or even using credits for e-commerce transactions. Credits could be used to buy anything, especially when Facebook makes the 30% cut it charges worthwhile to those selling the product or service by bringing an audience to them, as it is doing through these open graph apps.

So there you have it. Facebook owns the majority of Internet users, is likely to keep them in the future, and has only just started to work out how to make money from them. In short, it’s a good long-term bet.

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  • http://www.brickmarketing.com/ Nick Stamoulis

    Facebook has proven over the past 8 years that it has what it takes to evolve and remain relevant.  With the IPO, there will be even more pressure to do so and it’s doubtful that the social media giant will let us down.  

  • Lillo1980

    Facebook (FB) is a great company…no doubts: growth, innovation and leadership are the keyword in Menlo Park.
    But investing is something different…investments must be valued on two dimensions: one in favour of FB, one in the opposite…
    First of all, quality of the company: it’s out of doubt that FB will be able to grow, to expand their business lines, mobile advertising, bla bla bla…
    But more importantly, valuation! FB is trading at 12 times expected 2012 revenues, 30 times operating profits and 60 times earnings. Other quality stocks (Apple and Google in primis) are trading at multiples five times lower. It means that if GOOG and AAPL will continue to grow for the next 5 years @ 10% CAGR, FB will have to grow at least 50% to justify this price (33$, already more than 10% off IPO price). It means for them to reach in 2016 revenues of around 17/18 bln$. Consequently, to be a good investment they have to reach more than 20 bln in 5 years (17/18 is already in the price)…feasible? of course yes, but is it a good risk/reward? I don’t think so…