$100bn is Right if Facebook is the New TV

Facebook’s stats are amazing:

  • A huge and loyal customer base: 845m users, of which a whopping 483m are daily active users (DAU).
  • Dream margins of 75-80%.
  • Cash reserves of $3.9bn, with the IPO come $5bn more.

But is Facebook worth $100bn? This means 17x 2012 sales and a P/E ratio of 60. Google’s current Price/ Sales is 5 and P/E is 20.

Discussing Facebook’s valuation, many internet pundits have quoted and retweeted a blog post by Silicon Valley VC Bill Gurley . Gurley’s excellent blog post lists several reasons why Facebook should be valued in the $70 to 100bn range. Regarding the much-cited threat of Google+, Gurley, who knows a thing or two about internet platforms, says that it is very, very hard to leave Facebook. Nobody likes to leave their friends behind.

In a recent CNBC show, Facebook was called a “beast.” The journalists went on to say that Facebook is “not a dotcom” but instead a “real company.” Nice statement, considering that Mark Zuckerberg’s Letter to Shareholders in the Facebook SEC filing begins with the words: “Facebook was not originally created to be a company.”

Facebook certainly isn’t a normal company and this is not your average IPO.

Thank you Wikimedia, Creative Commons Licence, for file reuse.

But if Facebook is to be valued at $100bn, it needs to grow. And growth does not mean number of fans, but paying advertising customers. In 2011, Facebook grew by a stunning 88%. But in Q4 2011, the company grew only by 55%. In it’s February 1 SEC filing, Facebook itself states that an 88% growth rate is not sustainable.

The global advertising market is an established industry. There are only two ways to grow: (1) Take revenue away from other competitors currently generating ad revenues, or (2) grow the advertising market as a whole.

The global advertising market is huge: $464bn in 2011 (all figures from Zenith Optimedia). However, the market itself does not grow significantly (+3.5% last year). And Google will soon make up almost 10% of the global ad market. Google already accounts for 44% of total internet-based advertising. Can the ad market sustain another rapidly growing internet gorilla? If Facebook starts to eat into Google sales, this would be detrimental for both companies; there would be little headroom for Facebook and it would be a savage and expensive competitive fight.

Offline to online substitution is the key. While Google sales grew by $9bn in 2011 alone (from $29bn in 2010 to $38bn in 2011), newspaper ad revenues were in constant decline in past years (dropping from $95bn to $91bn). Mind that we are comparing a single company to the whole newspaper industry. Of course, Google is not alone responsible for the decline of newspaper revenues, but there certainly was a competitive shift taking place with revenues moving from offline to online.

Facebook has a lot of potential to convert offline ad sales into its own revenues, too. Facebook ads have better branding power than search ads, so it may even have an advantage to Google. Facebook’s attack trajectory is against TV. With revenues of $184bn (2011), TV is much bigger than newspaper publishing. There is enough headroom for Facebook here for the next couple of years.

Can Facebook pull off being the new TV, at least in terms of attractiveness to advertisers? TV is the domain of large advertisers, such as Coca Cola. Coca Cola’s ad budget in 2010, for example, was $2.9bn.

A shift will not happen overnight, and television is a beneficiary of massive events, like this year’s Olympics in London. Facebook will certainly do all it can to persuade large advertisers to shift part of their ad spend. Getting large advertisers on board is the Number 1 challenge Facebook will face in coming months.

It is possible, however, that Facebook has the power to grow the whole ad industry. I hate to use the Groupon example, because the company has in my opinion been poorly understood. But Groupon uncovered a new hyperlocal demand for advertising among small, mostly service-based companies, which had been improperly addressed by conventional advertising offerings. There is no other way to explain Groupon’s massive growth in such a short amount of time.

Facebook has this potential to uncover new demand, too, but in many more ways than Groupon. Facebook is a top mobile application. Facebook’s mobile apps do not show ads now, but that is being changed as you read this blog post. Facebook ads can be hyperlocal (restaurant in your part of town), hypertimely (there is a sale near where you are right now) and hypertargeted (new book by your favorite obscure Brazilian author).

Facebook will generate new sources of ad revenues from millions of small companies who have never relied on advertising before.

The only limit to Facebook’s ability to generate advertising revenue growth is Facebook itself. The trick about advertising- offline and online – is not to overdo it. In the book SimplySeven I co-authored, we describe the downfall of MySpace, at one point in time much larger than Facebook. The quantity and quality of advertising always needs to be delicately balanced and MySpace simply overdid it, going for short-term cash instead of user satisfaction.

Facebook clearly recognizes the danger of ad overload, however. To quote again from Mark Zuckerberg’s letter in the SEC filing: “Simply put: we don’t build services to make money; we make money to build better services… These days I think more and more people want to use services from companies that believe in something beyond simply maximizing profits.”

Facebook will continue to grow if it executes well. Smaller advertisers will discover and use Facebook for hyperlocal, hypertimely and hypertargeted ads, even through they did not advertise much before. The bigger challenge probably are the large ad accounts, which embrace the branding power and emotional quality of television.

There may be a third source for revenue growth, however, beyond advertising. In a previous blog post, I described how the internet flagship companies eBay, Google and Amazon already generate US$1bn each with complementary business models – on top of its original business. Already today, Facebook derives more than half a billion (15%) of sales from non-advertising sources, the bulk of this probably from Zynga. Zynga sells virtual goods in its games, providing Facebook with a commission (it also buys advertising directly on Facebook). There is more. Imagine if Facebook would offer premium subscriptions to its 845m members. Or if it offered its own (cash-) payments system like PayPal? At the moment, Facebook is still focusing on its primary revenue model advertising and the challenge of winning over large accounts, but the potential for growth on top of advertising itself certainly is there.

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