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Summary:

Everyone has been weighing in to decry the excessive hype leading to Facebook’s reported $50 billion valuation, but Ethan Kurzweil is convinced that it will rank as one of the best stock opportunities available today.

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Everyone from The New York Times to Fortune to CNN has been weighing in to decry the excessive hype leading to Facebook’s reported $50 billion valuation, as if there’s some immutable law of nature that private Internet stocks can’t be worth that much.

I don’t have any inside information about Facebook’s finances, and I’m not a Goldman client. But I’m convinced that when we look back at this investment, it will rank as one of the best stock opportunities available today — akin to buying Apple stock just before the release of the iPod.

Yes, there are many examples of unjustified Internet hype in the market today, but Facebook isn’t over-hyped; it’s simply an exception to the rule, a once-in-a-decade occurrence of a company that fundamentally changes the way we live and work, and has built a profitable business with huge growth prospects in the process. Let me explain why I’m so sure of this.

Advertising isn’t a business model? Tell that to Ogilvy

Detractors point to Facebook’s business model — advertising — as evidence that the company can’t possibly be a big business. Isn’t advertising a $210 billion business in the U.S., and about three times as big globally? So the objection could be that Internet advertising isn’t “real.” But hold on: internet advertising is expected to be a $25 billion business and grow 70 percent by 2015. And while SNL Kagan doesn’t yet break out social advertising as a category (I bet they do soon), Facebook reportedly did close to $2 billion in revenue last year; pretty good for no business model.

Sure, there is something behind our general fatigue toward websites with online advertising-based business models. There are innumerable small, sub-scale sites that can’t get the attention of premium, brand advertisers that drive the bulk of this spending, due to the small, fragmented size of their audience. But let’s not throw Facebook under the bus based on this. This is a site that reaches 500 million, sorry, no, 600 million people–- half of whom log in every day -– with a wealth of data that allows targeting on a level never before seen. Want to run a campaign that reaches fans of Natalie Portman? Facebook just happens to know 61,860 of those in the US. What about Lady Gaga fans who speak French? 23,060. Men who like Aardvarks? 2,260. You get the idea.

Detractors point to the current state of Facebook’s sales team and ad units as evidence that it won’t be a big business. I sometimes hear people say “well, I’ve never clicked on an ad, so…” usually trailing off afterwards. Think of it a different way: Facebook built a business with $2 billion in advertising revenue, and you’ve never clicked on an ad? Imagine how big it will be when you do start clicking…regularly. The television industry has had 60 years to evolve its ad formats and sales forces; Facebook’s only been at it with any seriousness for the past three or four years. Give them another two or three to get it perfected.

Facebook has sound fundamentals — no, seriously

Let’s assume that the data reported in The Wall Street Journal is accurate, and that Facebook ended 2010 with close to $2 billion in revenue, implying $500 to $600 million in profit using the range of reported profit margins. That’s a revenue growth rate of 157 percent and a profit growth rate of 150-200 percent from the $200 million in profit reported for 2009. If true, it would actually be conservative to expect their profit to double in 2011, implying a forward P/E of 42-50 for the Goldman investment, which puts it right in line with those of Amazon (53), Baidu (45), and Netflix (49). What’s so unreasonable about a forward P/E of 50 for a company like Facebook with an audience size and engagement level that implies many more years of doubling revenues and profits ahead?

The problem is that now that financial data is trickling out, we’re comparing Facebook to public stocks of similar size, and public market investors just aren’t used to companies that have more than doubled their revenue and profit in the past year and can credibly forecast to continue to do so – for at least a few more years. Comparisons to Google’s current financial ratios are spurious, for Google’s several years of post-IPO meteoric growth are well behind it. The company has grown less than 10 percent a quarter for the past 5 quarters.

Facebook is no one-trick pony

The vast majority of Facebook’s revenue today comes from one form of advertising or another. Remember last year’s brouhaha over Facebook Credits and Facebook taking a 30 percent cut of developers’ revenue? Given the size of companies like Zynga (once estimated to generate $50 million in revenue per month), won’t that be an even bigger number over time? Considering that Credits weren’t rolled out until the end of 2010, I’d think of this entire business as “new” over the current revenue base. And given the company’s breadth and usage, who’s to say that Facebook couldn’t make a run at other, already proven business models like Web search and local advertising?

Think Apple Stock is too expensive? Buy shares in another visionary

Call me old-fashioned, but here’s something else Goldman clients are buying with their Facebook shares: a team led by a visionary, not unlike Steve Jobs, who’s highly skilled at predicting our future modes of personal communication and interaction. In Mark Zuckerberg, Facebook’s stockholders are getting someone who has the foresight to shape the future patterns of how we spend our time and keep in touch. And he’s demonstrated an ability to execute on these prophecies in spite of protests by the vocal masses. Remember the uproar when Facebook released its news feed back in 2006? The company apologized at the time for a lack of communication but completely ignored the general consensus and kept the news feed intact. Anyone want to eliminate it today? It’s now the focal point of the site and the basis for zillions of hours of activities and eyeballs. Remember predictions that no one would spend their time using applications on the Facebook platform? Tell that to the 18 million people that played CityVille today, and the 2.5 million developers building on the platform. And these are just a few of the many product innovations like photo tagging that Facebook has made commonplace.

What could possibly go wrong?

Well, plenty of things. We all remember AOL and Myspace. This kind of skepticism has plagued Facebook at every turn –- only to be dismissed as the site achieves the next milestone and continues its exponential growth without missing a beat. I’m sure eventually there will be another technology juggernaut that emerges to steal back our time and scare Facebook about being disrupted. But this has never happened overnight, and no one is pointing to a company or idea currently out there that presages Facebook’s irrelevance.

I look forward to Facebook going public so that we finally have access to its financial data. Only then can we advance this debate as to whether we’re truly looking at a “once-in-a-decade” kind of company. In the meantime, I’m sure we’ll see a lot more backlash against the “hype.” I won’t have time to read it though; like a lot of you, I’ll be too busy perusing photos of Bali beach vacations taken by junior high-school classmates to whom I haven’t spoken in years. And maybe I’ll even click on an ad or two in the process.

Ethan Kurzweil is a Vice President with Bessemer Venture Partners in Menlo Park, California. He works with Internet companies of all types, including Playdom, Zoosk, Crowdflower, Twilio, Reputation Defender and OpenCandy. You can find him on twitter at @ethankurz. The views expressed in this post are his own, and do not represent those of Bessemer. Disclosure: Ethan has a very small position in a Facebook secondary vehicle, purchased in 2010.

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  1. My 14 year old daughter and her friends were talking the other day, I heard them say something like:

    “Her mom is on facebook? OMG, it’s for old people now”

    Something will replace the fad that is Facebook, and their trajectory will flatten out, or worse.

    Message to Menlo Park: There is no magic, don’t make another bubble, back legitimate companies that do something real like save people money.

    Reminds me of the movie Boiler Room.

    The reason FB reminds people of AOL is because they are very likely going to become the next AOL.

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    1. FB it’s for old people now; that’s funny. I guess Kids move on to the next “big” thing; it’s like wearing cloth from last year. It’s just not more hip LOL.

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    2. Myspace was a kids fad that never caught on with adults. FB is different. It may have started with kids, but now it’s used by enough adults that they can sustain the product, even if kids move on. People are uploading more pictures on FB than other photo sharing sites for example. Things like that make it difficult to just jump ship and go someplace else. I’m not saying it’s impossible, but it’s different that AOL, YAHOO and others, including Google. FB is holding a lot of our data and making it harder every day to leave. So who cares what a 14 year old thinks? FB can thrive without them.

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    3. Yeah – I agree 100% with this. The youth will soon jump the FB ship unless Facebook does what it should have done a long time ago. Allow users extremely easy and quick ways of choosing who can or cannot see what they publish. Each time you post a status update, photo, or comment, you should be able to quickly and easily choose what group of people will have access. If they don’t make they happen soon, the kids will flee. No kids wants their uncles, aunts, parents, grandparents, parent’s friends, etc watching them socialize online.

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      1. LOL! … As parents, we wanted to see what our kids were saying. We had enough embarrassing things said by our kids or to our kids and we needed to keep an eye. Any parent NEEDS to do the same, even if just to make sure no child predators or other dangers are lurking. Our house rules for facebook for our teenagers:
        1. No secrets, your parents ARE on your friends list.
        2. You post as if the whole world can see it. Because eventually they can and will. Yes, that includes stuff that ‘only’ your 500 ‘friends’ can read.
        3. FB is a time-waster, so time on it is limited.
        Now if that turns them off FB and makes them retreat to SMS’ing their friends, great!
        I am in the skeptic / what’s the big deal camp on FB’s durability as a mega-mover in technology, although I have found it useful, and its now clear that this business is the ultimate ‘network effort’ business, beyond what Ebay pulled off. The skeptic part comes in the mindset that FB is the largest site and overwhelms the other 99.9% of the internet. That’s a mystery. I mean if you are going to waste time on the internet, isn’t there stuff more exciting out there than FarmVille and tagging someone’s pics?
        Someday, people will be liberated from Facebook just like a previous generation was liberated from AOL, and they will gratefully acknowledge “So, I can be ‘social’ with my friends and be all over the internet at the same time? Huh, fancy that!” That day may never come if the gorrila uses FUD he way MSFT did to keep their mkt share, but it well might.

        That said, if Google could be a $200 billion ad-based company, why not others in that space? I find Facebook at $50 billion less absurd than Groupon at $6 billion.

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    4. Yes facebook is/was cool and so was the ipod.

      I wanna buy Apple stock before the ipod release.

      What about you ?

      People who dismiss a technology as being cool and hence a fad are blind. They cannot see the utility. They can’t see that Facebook is a disruption to the entire internet. Facebook is a disruption to communication.

      They couldn’t see the ipods and iPhone’s significance.

      Good for them

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      1. disruption and significance don’t mean you will dominate forever. Surely Friendster and MySpace already demonstrated Social networking is here to stay, but any one social website can be replaced. MySpace used to be cool too.

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    5. Facebook was never intended to be used by your 14 year old daughter…so as your 14 year old daughter complains that a 40 year old mom is on facebook, a 20 year old college student (which the website was intended to be used for) is complaining that your 14 year old daughter is on it.

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  2. Even $2B revenue does not justify $50B valuation.

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  3. Please, comparing Zuckerwhatever to Jobs is an insult to most sentient beings.
    Overpriced, overhyped.
    Zucker should have accepted the deal Jobs was trying to offer to integrate fb with iTunes.
    I know which co. will be around and profitable for longer

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    1. Format C and FB is gone. Just a Air bubble.

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  4. Ethan – great post. I couldn’t agree more.

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  5. Agreed, good post, though I think saying “it’s like Apple before the iPod” is going a bit far. Apple has gone up nearly 30X since the iPod release, and I don’t think Facebook will ever be a $1.5T market cap company. I know you don’t either, and it’s just an analogy, but my point is that I see the company as more like buying Google right after the IPO, where you get a 5X on your money if everything goes right but a ton of value has already been priced in. Still a great deal, but not necessarily “one of the best opportunities available today” — the pricing is just already too efficient. Your analysis on market size shows there has to be an upper bound here that’s a single digit multiple.

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  6. Are the people making skeptical comments aware that they are participating in a form of social networking while descrying it?

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  7. If you’re in it for the long run – the history of the world tells us you’re in deep trouble. I’d give it 5-7 years tops. They are losing the audience they started with…end if the day this is Friendster, MySpace….

    Best part is – for the paranoid, selfish, petty idea stealing loser M-Zuck is…the fall couldn’t happen to a better guy!

    I will enjoy it!

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  8. Ethan, I liked you post, but when you said “Imagine how big it will be when you do start clicking…regularly.”, I’d like you to tell me what would make me click on them actually? That’s critical. I’m not really sure I want to click some ads on FB.

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    1. Brilliant Pebbles Sunday, January 16, 2011

      I think that’s the real question. I’ve seen online ads for some 15 years (if you include my Prodigy account) and the number of ads I’ve clicked on could be counted on one hand. What will make a Facebook ad so special that it will do that which AOL, Geocities, and every other website fail before them? As I look at the landscape, the only company making ads really work at their valuation is Google.

      Once in a decade? How about lightning striking twice?

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      1. So how many ads do you click on television? A lot of companys still seem to think it’s a viable medium

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    2. It’s a good question actually but one that I’m convinced Facebook will solve over time. No one clicked on ANY display advertising at first – now that’s $10b+ industry and Google took many years to find the best business model and ad placement such that people clicks – but without interfering with the organic search experience.

      Facebook is beginning to get this right as companies like Zynga and Zoosk demonstrate (lots of people click on their ads). I don’t have the answer but with enough rapid experimentation, I’d be shocked if they couldn’t figure it out.

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    3. I suppose his point was that ad acceptance will rise as the FB ad system will become better and increasingly personal.
      The more relevant an ad is to you, the more likely you are to submit to it, regardless of your threshold (not considering ad-blockers, etc).
      Relevance is hard to achieve if your customer data set is poor; Facebook simply doesn’t have this problem.

      The local fish store around my corner can use Facebook to advertise itself to the 3000 out of 3001 inhabitants of my village who are on Facebook. I’m not aware of any other platform that has a data set of equivalent value (provided FB upholds its market penetration).

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      1. Great points, Jack – and I think you clarified well what I was trying to convey. Couldn’t agree more about the data and degree of targeting; we’d be hard-pressed to find any other site with broad reach that can provide that kind of precision to its advertisers.

        Decrying internet advertising – as some are doing here in the comments – belies the fact that it’s already a big industry and growing much more quickly than any other advertising medium.

        And to Brilliant Pebbles – AOL hasn’t exactly failed to generate advertising revenue – that’s a $1b+ business for them. Sure, the dial-up business is rapidly vanishing but that’s kind of a red herring to this discussion about advertising as a viable business model. The truth is that Google’s been dependent on advertising for a long time and they are still a healthy, almost $200b market cap company.

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  9. Nice post, thanks for your thoughts. I’m unsure of a $50 billion valuation and the prediction that FB will continue with it’s current growth rate. I’d expect it to flatten to the degree it is add revenue dependent. The value prop to advertisers of FB’s targeting data will wear out as more businesses realize that there isn’t great ROI on this spend despite the targeting; right now the newness of it is too much to resist.

    I agree the are innovative, well led, and talented and that they’ll find another revenue stream through credits, or rev shares of 3rd party sales executed on the platform, but real valuation will need to extrapolated for that as a long term biz model. But attempts to weave advertising into the meaningful pieces of the site (beacon) haven’t gone well.

    It also may be that I am simply wrong and there’s enough ad spend from big brands that are more concerned with eyeballs than measurable ROI to sustain FB because it is very engrained in society and will stay so in some capacity for a while, especially as they grow in new markets for them like India and Indonesia.

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  10. It may or may not be overhyped as a company, but from an investment perspective, YOU are definitely hyping it up!

    Apple’s stock before the iPod was launched was less than $10/share. In other words, it’s appreciated about 35x since then. For Facebook to achieve that kind of appreciation, they will have to be worth $1.75 TRILLION someday, which is between 5-6x what Apple is worth today as the world’s 2nd most valuable company.

    Is it possible? Sure, anything is possible. Just like bloggers writing articles that have some basis in reality. Sure, it’s possible. But not likely.

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