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Intelligent Speculator

One More Sign That Facebook (FB) Needs To Be Owned

January 24, 2013 | About:

A couple of weeks ago, when I put Facebook (NASDAQ:FB) as the top social media play and near the very top of my tech stock power rankings, I was told that Facebook’s potential remained limited, that its revenue growth was very uncertain and that my arguments were shaky. I’ve said from the very start that Facebook should not be valued based off of its current revenues. Its strength is in its user base and its data. You’d be foolish to think that Facebook’s future depends on those little banner ads at the right of the screens.

TickerNamePriceP/ENext Year P/ESales Growth

*Facebook is scheduled to report Q4 earnings on January 30th

Facebook’s Evolution Continues

Facebook started off with banner ads, has also been integrating ads into newsfeeds, offering the ability for users to send each other gifts, offering credits to simplify life of merchants and users, etc. Today, Facebook finally confirmed it would be entering the search market with social graph. Thanks to all of its data, it will be able to help users find people, places, businesses, music, games and more.

How Social Graph Search Could Work

Facebook is gathering data about all of us, what we like, what we don’t, what we talk about, where we work, who are friends and family are, etc. That data can become very useful. For example, through its partnership with TripAdvisor (TRIP), Facebook knows where many of my friends have been (hotels, restaurants, etc). The other day, I got an email about the top 25 hotels in the world from TripAdvisor telling me which friends have stayed where. That and a lot more is data that Facebook has access to and could enable it to make a competitive search product. If I’m looking to buy a car, it would be incredibly useful to know which of my friends drive that car and what they’ve said about it. Then, Facebook could sell very targeted advertising knowing that I’m shopping for a new car.

That seems like a win-win doesn’t it? I’d venture to say that the number one complaint from Facebook users was the poor search experience. That is about to change and there are a lot of dollars to be made there. How much? Google is getting more diversified but still depends on search ads for the vast majority of its revenues. Getting even part of that market which is estimated at $15B would be a major win.

At just 5% of the market (which seems like a conservative estimate), Facebook would be adding over 20% to its existing revenues. This will also help Facebook promote its places and deals businesses which comes into direct competition with Yelp (NYSE:YELP). If you’re wondering how the market reacted to such competition, just take a look at Yelp’s chart following the announcement on Jan 15th


Despite Its Size, Facebook Is Still Acting “Small”

One of the challenges for big tech giants is becoming so big that everything gets slow. I don’t think anyone would argue that Microsoft reached that point a long time ago. Google had as well but since the return of Larry Page as CEO, Google has improved significantly. I’m still impressed by Facebook’s speed in launching new features. For example, just a few weeks ago, it started testing free VOIP for Canadians. Tests did not go on for too long as this week Facebook announced the feature was available for all US users as well.

In This New Digital Economy…

Do you doubt the importance of owning Facebook? Yes, Google (GOOG), Amazon (AMZN) and Apple (AAPL) are clearly huge players but I’d argue that Facebook has a shot at becoming the biggest. Could it be the next MySpace? Yes, it’s possible. I do remember how many said Google would become the next Altavista some years ago. At some point, a product can become so superior and its critical mass of users so big that it becomes nearly impossible for competitors to step in. Just ask Microsoft how difficult it’s been to challenge Google in search?

Try thinking about all of those local businesses that have recently started using Facebook? Don’t you think they’d be willing to pay Facebook to come out at the top when users search for: “Best restaurants in Los Angeles”?

At some point, if someone is looking for such a restaurant, Facebook could offer them an easy way to buy a coupon with Facebook credits, let them know about special promotions, etc. it all ties together and it’s a dangerous trend for Google. Why? Because everything happening in Facebook’s walls is off-limits for Google (it can’t access the content or index it in its search engine).

Facebook Risks

As you would expect with any stock that has upside, there is certainly risk involved for Facebook shareholders. One major point is how much it depends on users trusting the site. Just a few weeks ago, privacy policy changes at Instagram (owned by Facebook) backfired with thousands of users leaving the service. If Facebook ends up stumbling in such a way, the consequences would be severe. Facebook depends on users continuing to upload data in order to remain relevant both as a social network and for other initiatives such as search. The day users stop sharing would also mean the search engine would lose relevance. In my opinion, the risk of self implosion is Facebook’s biggest risk, much bigger than competitors such as Google+, LinkedIn (LNKD) or Twitter.

In The End Though

Facebook is adding new revenues sources every few months, has a ton of upside and some risk. I would argue that the upside is very significant and the downside isn’t.. that sounds like a stock you need to own don’t you think? I know I do!

Disclaimer: Long Facebook (NASDAQ:FB)

Rating: 3.0/5 (4 votes)


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