The Importance Of Critical Mass To Facebook's Social Network And Metadata

Nov. 6.13 | About: Facebook (FB)

This Facebook (NASDAQ:FB) article serves to assuage investors' worries regarding several misunderstood thematics surrounding FB and its latest earnings call. Over the past few days, much has come out regarding why FB doesn't deserve the valuation it currently has. These pundits claim variously that social networks are born to die. Unfortunately, these same pundits do not recognize that history doesn't always necessarily repeat itself.

History as Our Teacher: The Network Will Crumble As Users Exit

The seemingly most prevalent concern expressed by investors deals with the notion that FB will necessarily suffer the same fate as its predecessors. More specifically, one Seeking Alpha user cites slowing penetration in the US as a red flag signaling the demise of FB, "[t]he same red flag that signaled the death of Friendster and MySpace." While this certainly is plausible, we must note the way Mark Zuckerberg presciently waited for his social networking site to hit a critical mass--which one must assume was roughly one-billion users given the IPO date--before going public and thereby subjecting FB to the whims of the market. By waiting, one can infer that Zuckerberg likely had this same "red flag" in mind with regards to how users leaving his social network certainly could affect its long-term viability. In short, Zuckerberg has already accounted for, and strategically limited, the possibility of his social networking site suffering the same fate as others before FB, namely Friendster and MySpace. This logic makes more sense when considered in tandem with Malcolm Gladwell's popularization of "the tipping point".

Interestingly, at their peaks, Friendster had over 100-million registered users while MySpace had roughly 76-million registered users. As we've already noted, FB has already surpassed the billion-user mark. By juxtaposing these numbers, one can better understand this notion of critical mass seeing as this number is over ten-times even Friendster's peak user-number. Thinking about it another way, if someone has a three-legged table, and the table loses one of its legs, the table falls. However, if someone else comes along and understands that a table will lose a leg or two sometimes, and as such, they make a table with ten-times that number of legs? Exactly--the table will still stand even if it loses a leg or two along the way.

For Zuckerberg and FB, losing users incrementally, on the margins, has less of an effect because he waited for critical mass to get achieved.

Now, maybe Zuckerberg didn't intentionally wait for one-billion users, maybe he did. I expect my position remains clear on this, but nonetheless, the bottom-line remains: once critical mass has been achieved, the trend spreads like a virus and replicates itself so many times that it cannot be eradicated. This is FB, for better or for worse. Users will certainly leave FB's social network, but at this point, it matters little. In other words, the likelihood of a user-created internal shock to the system has become very remote. As such, it would take a rather large exogenous shock to the social network, one that takes on a global scale, before anyone should necessarily start worrying about FB dying out due to user exits.

However, these FB critics confuse me seeing as the data point that seemingly created the massive sell-off following the earnings announcement was sparked not by user exits, but instead, by one executive's comments regarding teen engagement.

But Wait, Last Week's Earnings Call Said...

I can already sense some readers' frustration because they're caught up on what David Ebersman, FB's CFO, conceded during FB's earnings call last week, namely that younger teens appear bored with FB, evidenced by a slight decrease in daily active users (DAUs). Importantly, when Ebersman concedes this point on young American teens, he's simply helping FB get out in front of this issue. Eventually, someone would have asked about this metric, and it would have had to come to light. That's all FB did last week by having their CFO address "such granular data, especially when it's of questionable statistical significance" (i.e., young American teen FB users represent a single-digit percentage amount of total global users--more on this later). FB necessarily wanted to get out in front of this issue because it seemingly cares about transparency, for now at least.

In fact, if you read the transcript, you will note how Ebersman affirms that "[their] best analysis on youth engagement in the US reveals that usage of Facebook among US teens overall was stable from Q2 to Q3", though DAUs among younger American teens decreased over the same period. All this says to me is something we've known for a long time: American teens represent a fickle group who feel the need to branch out and try new things.

Additionally, and more importantly, these teens are not deleting their accounts; FB has an offering that will always be there, waiting patiently in the wings for teens to grow up. Perhaps FB will sing a different tune in five years as it tracks these "younger [American] teens"--oh, they're certainly tracking them--pointing out in a future earnings call the way FB has recaptured the attention of this segment since they've entered college. For it's in college where you create more meaningful relationships with friends, especially those who go to different schools, yet you want to stay connected all the same; it's in college where you have that online class where students have created a FB page to post and study from; it's in college where you need to sell those old textbooks / your unused football tickets / that no-longer-necessary Vespa with relative ease. And FB facilitates all of this happening, and teens already on it, waiting to discover the true benefits of the social network.

Nonetheless, investors have still created a maelstrom of activity over something that FB simply called out in the name of transparency. With roughly 40% of all Americans logging onto FB every day via the web--roughly 33% logging in daily via the mobile app--this uproar should not be happening. In fact, it seems the market is recognizing this now, seeing as FB popped today ~4%, settling in just above $50/share. Considering teens represent a smaller percentage of these Americans logging into FB every day--roughly 66% of US adults are on FB--then the metric that moved FB's stock with such volatility certainly means next to nothing. Perhaps now people will fully understand why FB refuses to concern itself with this small, incremental, US-centric metric regarding a small population of young teens. Finally, FB "remain[s] close to fully penetrated among teens in the US, [FB's teenage] monthly user numbers remain steady, and overall [teenage] engagement on Facebook remains strong" anyhow.

Well, What About Twitter Then?

FB bears will now eagerly pounce to denounce FB as a viable option in the future, not because of user exits (i.e., critical mass has been achieved), not because of the earnings call (i.e., that US-centric metric on young teens matters not), but instead, because they claim people in the US are switching to Twitter, and that that matters. Well, let me tweet that it does not worry FB very much.

PewResearch Journalism ProjectFirstly, a new PewResearchCenter study proves only 16% of US adults even use Twitter today (remember how ~66% of US adults are on FB?). Read another way, one must note that this means 84% of US adults do not use Twitter at all. Many pundits even claim that news consumption is switching to Twitter, but unfortunately for them, they're just blowing smoke: the new study highlights how only 8% of US adults consume their news via Twitter. This small percentage compares with the 30% of US adults who consume news via FB. I don't want to call these critics liars, but that research sure doesn't lie.

But now these bears will grumble, "What about the teens? Surely they're leaving FB for Twitter!" Well, independent research conducted earlier this year by the PewResearchCenter notes how teens, while certainly gravitating toward Twitter, still find FB a necessary component of their social life, despite privacy concerns and an ever-increasing adult presence on the site. They may use Twitter, but that study shows they have more than 4x as many connections / friends on FB. A decrease in DAUs within this younger teenage segment obviously was worth noting, but again, it's nothing to sell off FB on.

Not yet, at least.

Closing Comments

Please note, the above arguments aim to present facts that address the numerous concerns expressed by other users regarding why I feel FB certainly has a proper end game in mind that they can ultimately monetize ("Facebook's End Game and the Long Road Ahead"). I have much more to discuss on the merits of FB and the long-term viability of it as a social network and publicly traded company. In fact, the majority of my additional analytical thinking on FB remains embedded within the notion of first-movers not always succeeding, which has been coined the second-mover advantage. FB certainly wasn't first-to-market with its product, but thanks to Zuckerberg's relentlessness, married to his extreme intuitive smarts on how the world thinks and operates, FB has built itself as bigger, better, and "badder" than the average social networking site.

As all can now hopefully agree, at the moment, FB isn't concerned with incremental user exits; FB knows it has a product that steadily increases in usage across the world and has, by now, become self-sustaining. When we as investors become overly concerned with such a small US-centric metric, we highlight our ignorance regarding the way the world operates, proving to people everywhere how ethnocentric we are. As many do know, but obviously not enough know, FB has growing influence in many areas not considered the western world. That is necessarily what Zuckerberg and others within FB are concerned with, so why shouldn't we as (potential) investors?

Importantly, when FB hit the one-billion-user mark last year, it released statistics showing just how much it does in terms of connecting the world. Since 2004, it has created over 140.3-billion friend connections; since the introduction of the "Like" button in 2009, over 1.13-trillion "Likes"; and, perhaps superfluously, it has also facilitated over 210,000 years of music listening (sorry, MySpace). That, dear friends, is what metadata represents--the creation of data about data (e.g., FB can tell you the sequencing of things "Liked", representing trends within specific demographic groups). And when you augment this metadata with the fact that, for many, FB presents itself as an addiction that can only be topped by sleep and sex, FB has little to worry about in terms of users not using anymore. They need their fix, and as I've previously argued, this creates marketable data FB can ultimately parlay into billions on the market-research front.

Please note, I'm certainly not claiming to be absolutely correct. However, looking at the variously arranged facts strewn about us, when I piece them together like a jigsaw puzzle, I can't help but see FB's future as bullish. Nonetheless, I look forward to new evidence coming to light that either affirms or denies my position seeing as I'm certainly looking out much farther than the average bear.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FB over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.