You know that I’m a big believer in Facebook (FB) and have said in the past that it was one of the best bargains out there. After seeing the company finally file for an IPO, I’ve had dozens of discussions both with active investors and the typical reader on this blog. I’ve also been watching TV, reading newspapers and magazines. It seems like the same opinion is coming up over and over. Those 5 or 6 main reasons why buying Facebook at a $100 billion valuation is a bad idea. I don’t love being on the opposite side of the majority but in such a case, I’m more than ready to argue with anyone who thinks that this is the latest sign of a new internet bubble. Most of the arguments are flawed in my opinion. In fact, a recent WSJ poll had the majority of those polled saying Facebook was worth less than $75B.
Let’s start off by looking at a few things that are being said:
Theory #1-Facebook Has Already Peaked At 800M-1B Users
Myth Explained: One, if not the biggest, argument that is being brought up is that Facebook’s days of high growth are a thing of the past. That with already nearly 1 billion users, there is very limited space for growth.
Counter-Argument: I would argue that it’s irrelevant to look at the growth in users. Sure, I want to see Facebook continue to be the dominant social network but the growth number that we should look at is not “users growth” but revenues/profits growth. That number is growing at nearly 100% and I would argue that it will accelerate in the coming years.
Theory #2-Facebook No Way To Monetize Its Users
Myth Explained: Facebook is seen by many as being a one trick pony, that can only count on advertising to grow revenues.
Counter-Argument: First off, that one trick is a darn good one. The other company that has been getting the same accusation is Google (GOOG) which has managed to do fairly well in the last decade don’t you think? I would argue that as Facebook continues to evolve, Facebook Credits and a variety of other revenue sources will become big parts of the business.
Percentage of revenue generated from advertising:
Theory #3-Facebook Will Eventually Crumble In The Same Way That MySpace Did
Myth Explained: Over the recent 10 years, a large number of social networks have come and gone, each happening fairly quickly with News Corp’s MySpace being the most famous example. The launch of Google+ is certainly a viable threat to Facebook.
Counter-Argument: I think it’s important to say that I think there is some credibility to this argument. There is certainly a possibility that it could happen. I would add though that many said that about Google in search a decade ago as it was following the tracks of Yahoo (YHOO), Altavista, Lycos and others. Facebook does seem to have build a solid enough lead to remain relevant for a very long time. I don’t think the rise of Google+ will necessarily mean the fall of Facebook, as there is certainly enough space for both to co-exist.
Theory #4-Facebook’s Valuation Is Insane
Myth Explained: For Facebook to trade at over 25 times in 2011 revenues seems completely unreasonable.
Counter-Argument: Facebook has been a high margin business to this day and made nearly $1 billion in earnings last year. I would expect that number to double (more or less) this year, making the $100B valuation a forward P/E of 50 or so… that suddenly does not look outrageous, does it? Even looking at revenues, its valuation is much more reasonable than recent IPO’s such as LinkedIn (LNKD), Pandora (P), etc. The difference is that because Facebook’s numbers are higher, so is the valuation and a 100B valuation seems much more outrageous than a $10B one, even if the ratios are the same.
Theory #5-There Is Little To No Upside At This Valuation
Myth Explained: If Facebook starts trading at a $100B valuation (perhaps even more when it starts trading), how much higher can it go when you consider that Google (GOOG), the much bigger company trades at $200B with Amazon (AMZN) at $87B or so.
Counter-Argument: This one is certainly an interesting argument. When you consider that Apple (AAPL), the biggest listed company in the world is not even at $500B, it seems unlikely that FB could ever become a success story in the way that Microsoft (MSFT), Apple and others turned out to be (turning poor into millionaires, etc). I’d agree with that. However, I would say that it’s almost impossible to get those types of winning stocks and trying to do so seems like a losing proposition. However, saying that Facebook could become a $200-300B company within a decade makes it a much more attractive pick than most valuations you can find on the market.
Theory #6-Facebook Does Not Have As Many Users As It Claims
Myth Explained: Facebook has been claiming a large number of active users but the release of the fact that they consider even a user that clicks on a “like” button as active got many people wondering about the users numbers.
Counter-Argument: I guess there is some truth to that and if you are buying Facebook and valuing off of the active users numbers, that might be flawed. I would argue that it’s not that important. Users are not made equal and the fact that Facebook now gets 20% of all internet pages seen is more than enough to convince me of the solidity of their user base. What is the number? Difficult to say. But I would say that Google and Facebook are two names that have the most interactions with users by very far.
Theory #7-Zuckerberg Is Not The Right Guy For The Job
Myth Explained: Mark Zuckerberg has clearly made many mistakes in the years since founding Facebook out of his Harvard dorm and thanks to some smart moves, he still holds 57% of voting power in the company, enough to control everything going on. Does he have the right focus? “We don’t build services to make money; we make money to build better services,” Mr. Zuckerberg wrote. “These days I think more and more people want to use services from companies that believe in something beyond simply maximizing profits.”
Counter-Argument: Certainly, I can understand the concern but I would argue two things. First is that there is no doubt that Zuckerberg has improved a ton since starting the company. The company continues to face some questions, especially concerning privacy but I think overall the progress has been solid. Facebook continues to be focused on long term growth rather than the short term profits. That will likely make progress slower but I do think it is the right way to move ahead from the shareholders perspective.
So What Is Facebook Worth?
One of the more common comparisons is to Google. Take a look at this chart:
Source: The Telegraph
Revenue Per User
I would personally say that it is deeply flawed. Why? The main thing is that if you look at Google, the search engine’s model was fairly simple. Provide search engine results better than anyone else then put up ads on those pages. 10 years later, that is still the model that seems to be generating most of Google’s revenues. For Facebook, the story is very different as there are many different ways that Facebook could make profits. Advertising is one of course, but so are credits, taking companies that use its ecosystem (Zynga, TripAdvisor, Netflix, etc). Facebook could create a highly personalized ad target that would rival Google’s “adsense”. There are hundreds of different ways to do it but Facebook has not been working on those to this point. And I don’t think anyone could blame them.
How Would I Price Facebook?
I personally believe that the company will be able to keep up solid growth for 2-3 more years without any problem and hopefully increase its profits to $4-5 billion per year within 3 -4 years. That would imply very high growth but it’s reasonable in my opinion. At that point, the company could be trading at a P/E of 45 or so (in a similar range to companies such as Amazon (AMZN) and Baidu (BIDU). What would its value then be? It would be over $200B. Does that sound over optimistic? I don’t think so, I think those estimates are more than reasonable and I would even personally bet on strong growth in the next few years., But that range seems very reasonable.
There is downside of course but I do think that it is fairly limited which is always a great sign when evaluating a company such as Facebook.