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A Different View: Why Facebook Is Worth More & Wall Street Is Wrong

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Facebook is building great value for consumers and brands; it's a very valuable company. Wall Street's negative analysis completely misunderstands the Facebook business model -- and to some extent, the entire nature of the social media market.

The company can build to at least $33 billion/year in revenue. Even if its pre-tax profits drop from 40 percent-plus to a more normal high-tech 20 percent, it will yield $6.7 billion in profits, which at a conservative 15x multiple, results in a $100 billion market cap, with quite a bit of additional upside. I'm talking about Facebook's medium- and long-term value, with the basic assumption that ultimately a company's stock market value will follow its actual business value. I'm not referring to short-term stock value, as this is often driven by emotion, speculative behavior, lock-up factors, and frankly, who ate cheese for breakfast that day. I'll detail my credentials and interests in social media more at the end of this article; topline, I've been creating and managing online community and social media programs with Fortune 500 brands for about 28 years (yes, that's 28, 16 as LiveWorld and 12 prior at Apple). In particular, I've been driving social media ROI for these companies. I am the CEO of LiveWorld, a user content management company, delivering programs on Facebook, Twitter, and other social networks for the top companies in retail, CPG, pharmaceuticals, financial/travel services, tech, and ecommerce. I know much of what has worked and what hasn't. I have direct access to, knowledge of, and experience with the social media plans, successes, and failures of dozens of major brands, as today LiveWorld operates thousands of Facebook Pages, Twitter Pages, and online community sites.

The most important dimension to understand is that the Facebook business model is an ecosystem delivering deep usage patterns that are driving new value streams in marketing (brand building), insight, service & support, ecommerce, and entertainment.
The Wall Street critics appear to have missed this, and mistakenly view Facebook through traditional lenses of an advertising impressions business model.

The Wall Street critical analysis usually goes like this: Facebook is overvalued because:

  • It is a traditional advertising impressions business model in a company that is maxing out its potential with slowing growth (users, and therefore revenue and profit) and weak monetization of its eyeballs/ad impressions inventory.
  • It's in the volatile Internet and social media business, whose value some question in the first place, and in any case, switching costs are low, and Facebook has big and small competitors nipping at their heels.
  • 40 percent-plus of their usage is mobile and they haven't figured out how to monetize it.
  • Plus it's trading at PEs higher than Apple and Google, so it has to be over valued.
  • Last but not least, Facebook is controlled by an arrogant, confident young founder-CEO who has blatantly declared he will not listen to or be driven by his critics' failure to understand his business.

A different view...

In fact Facebook has a different, powerful, high-value business model:
  • Facebook is an ecosystem business model, dominant in social media, and innovating new relationship marketing, insight, support, ecommerce, and entertainment value streams.
  • The social media market opportunity overall is growing. The Facebook usage pattern is deep and strong, with tremendous upside to get deeper and stronger -- and to be monetized.
  • The largest brands in the world are finding substantial value in Facebook's ecosystem, are increasing their spend on Facebook, and are already finding success in the company's new marketing venues.
  • 40 percent of their usage is mobile, which they have yet to monetize. This is a tremendous upside as the US Internet industry (including Facebook) catches up to mobile advanced countries such as Finland and South Korea.
  • Facebook has been running at 40 percent-plus profits and is awash in cash. It intends to invest these huge margins and cash in developing the business.
  • It trades at higher ratios than Google and Apple. But those businesses are older and more mature. (Besides, Apple, even as the highest valued company in the world, is also an undervalued ecosystem. But that is a story for another article.)
  • Last but not least, Facebook is controlled by an arrogant, confident young founder-CEO who has blatantly declared he will not listen to or be driven by his critics' failure to understand his business.

Ecosystem Business Models & Usage Patterns

Most companies operate primarily in the context of their industry business model. Auto-makers make cars in the context of the auto industry business model; TV Networks, magazines, most Internet sites, even Google, and many others work in the context of an advertising impressions model. But a few companies, such as IBM, Microsoft, Apple, Nintendo, Sony Playstation, AOL for a while, and now Facebook, actually become the business context by establishing an ecosystem in which customers, developers, and other third parties (resellers, advertisers, etc.) all participate and build a massive asset infrastructure and series of value streams. The ecosystem becomes an economy itself, leveraging all the players, usually with the ecosystem company reaping the greater competitive barriers, the most revenue, and the largest capital value.

Let's look at Apple as today's most popular ecosystem reference example. The IOS operating system, combined with the iTunes channel and nifty hardware design, sets the context for an ecosystem that goes far beyond Apple's own products, to hundreds of thousands of applications, services, peripherals, resellers, repair centers, training, publishers, and advertisers. If we valued Apple as just a device company, or even a combination of device & operating system, we might look at declining hardware share with a proprietary OS as a losing proposition. But Apple has built an industry around itself, and commands a massive dominant share in actual usage of smart phones with apps and the web, all supported by that ecosystem. That dominant usage pattern drives high margin annuity revenue streams -- apps today, with advertising, ecommerce, and entertainment to be increasingly added over time.

Facebook has also built a unique ecosystem with a powerful annuity usage pattern, with hundreds of thousands of third party applications, devices, games, entertainment offering, publishers and advertisers. Facebook has even extended beyond it's own ecosystem with a distributed model in which Facebook engagement (likes), dialogue (comments) and even registration features are used by tens of thousands of other web sites. Many companies, including Microsoft, have tried to create a universal registration/sign on system and reap the resulting competitive advantages. Facebook has done it. Much has been made of Facebook's 900 million+ users and the slowing growth in that number. But the important number is the usage pattern, not the total number of users. Over 90 percent of Facebook's 900 million+ members use it every month. That's a previously unheard metric. Over 400 million users are active every day. (source: Facebook.) That is even more phenomenal in absolute and percent terms. It has never happened before in any media venue, online or off.

Overall engagement and time on Facebook have been rising over the last few years, and continues to rise each time Facebook advances the service with innovations such as Timeline. This number will ebb and flow; the important metric to understand is the upside in average user hours per month. Today Facebook averages about 6 hours per month per user (source: Facebook). What is the upside? TV time, currently at about 100 hours per month per user (source: New York Times) is shifting to social media -- in particular, to Facebook. There's a wide range of views on this; mine is that over half of TV time will shift to social media. If Facebook's average usage per month only grows to 36 hours (just over one hour per day and only to about one third of TV's pattern), that's a 6x growth in usage time. Facebook's usage pattern is also much deeper, and more personal, social, and engaging than television, which brings us to the richness of the new value streams.

Value Streams & Market Opportunities

Brand Building

Social media overall is displacing television as the primary venue for companies to build brands. By brand building, I mean awareness, positioning, product education, loyalty, and word of mouth. Study after study (as well as our direct experience) shows that television has for the most part become ineffective in brand building, even as social media is on the rise. Social media is on the rise as it becomes the primary engagement venue for consumers.

Consumers get three core primary benefits from social media; 1) self-expression and sharing themselves, 2) friends, and 3) attention. Secondary values exist as well; but it is these three fundamental human relationship values that drive the engagement, enabling brands to connect with customers in a way never before possible with scale. This is why the number of corporations using social media and Facebook is rising. CMOs are universally planning to increase their social media spend while they decrease traditional media spend, and Facebook has the lion's share of this spend (sources: Society of New Communication Research, eMarketer, CMO Survey). Wall Street critics looking at ad impressions are missing the brand-building model, but CMOs are not.

Wall Street critics likely mistake Facebook's brand-building value for an ad impressions model because they don't see or understand the new innovative marketing venues. For example, Facebook has eschewed traditional web ad models such as banners, ad words, and display ads, in favor of marketing venues that are consistent with its conversational, storytelling, and relationship ecosystem context -- most recently Sponsored Stories. With our Fortune 500 client base, we are seeing great success with Sponsored Stories in terms of generating reach (overall impressions), engagement (actions), and word of mouth (organic impressions or users commenting on the brand and it's stories.) Business Insider recently reported, "Sponsored Stories are way more effective than display ads." Our clients are increasing their spend on Facebook marketing venues, with plans to increase even more in 2013. Another way to look at this is to consider Facebook as a venue for brands to build relationships with customers, not ad impressions. As any marketer will tell you, a customer relationship is more valuable than a lifetime of ad impressions. See the Ben Elowitz Ad Age June 2012 discussion on this for more.

So what is the revenue upside for an ecosystem business model that dominates social media with a stronger usage pattern and new brand building value streams that are working well? The worldwide advertising market is running at about $588 billion in 2010 (source: Facebook). Some believe that social media will expand that market; but even if we hold to that number for a few years, for Facebook to reach $33 billion/year it needs to achieve a 5.6 percent market share. Instead of basing a forecast on total worldwide advertising spend, let's narrow Facebook's available market to just social media marketing. McKinsey & Company projects the 2011 available market for social advertising was $253 billion Facebook would need about a 13 percent market share to reach $33 billion revenue in that context. More conservatively, according to a recent survey of CMOs, they expect their social media marketing spend to rise in the next few years to 18.8 percentof their total marketing spend (source: CMO survey). That equates to $111 billion of the $588 billion. Against $111 billion Facebook would need 30 percent market share to reach $33 million in revenue. Noting that today Facebook holds a vast majority share of brand spend on social media advertising, is it reasonable to believe that Facebook with over 900 Million active monthly users, over 400 Million active daily users, deepening usage patterns, and releasing new innovative, effective brand building venues, can in the future have a 4 to 25 percent market share? I think that's a pretty conservative "yes," and with significant additional upside. But instead of relying on surveys or my view, let's go right to the horse's mouth. I attend meetings with the top marketing executives of Fortune 500 brands. To paraphrase one, "we believe the vast majority of our spend will move from TV (and other traditional media) to digital and social media." He then urged his team to speed up the transition. To look at more upside for a moment, let's project numbers based on the intent of these top marketing executives who actually make the spending decisions. Assuming the worldwide advertising market grows to say $700 billion in a few years, social is 50 percent = $350 billion, and Facebook holds a 20 percent market share. That would result in $70 billion/year revenue.

Additional Value Streams

While the Facebook case can be made just on brand building (versus ad impressions), this is only one of the high value streams brands will leverage in the Facebook ecosystem. Together these additional value streams total many tens or even hundreds of billions of dollars in market revenue and billions in potential revenue for Facebook. A broader view of addressable market based on the ecosystem model, would look at the overall impact of social media technologies. McKinsey projects this at $900 billion to $1.3 trillion as the annual value that can be unlocked by social media. In that case, Facebook would need less than a 3 percent share of annual value to achieve $33 billion in revenue.

Insight: Social media puts customer conversations right in front of brands, enabling an unprecedented opportunity for understanding what customers think and what to do about it -- and in turn, for improving their products, marketing, support, and revenue. CMOs regularly list insight as a primary value of social media. Our Fortune 500 clients again and again are working with us to better leverage social media insight to impact their businesses; we are finding this to be one of our largest areas of growth. The worldwide market research market is about $30 billion, with top players garnering $2 to $3 billion each (source Siemer & Associates). Facebook today, compared to the resources of any market research firm, has the largest pool of connected customers, the deepest usage pattern, the largest conversation base, and the most information about it.

Service & Support: Consumers list service and support as a main value of social media, and they expect brands to respond to them. The 2012 American Express Global Customer Service Barometer Study showed 2/3rd of customers are willing to spend more with a company that provides excellent service on social media, consumers who have used social media for service wield the greatest amount of influence and on average will spend 21 percent more with companies that deliver great service compared to 13 percent on average. In our experience at Apple and with our LiveWorld clients, brands can use social media to simultaneously increase customer satisfaction and sales, while reducing the cost of customer support. Social media as a venue for service and support costs 1/2 to 1/10th of email and phone support, while creating more customer loyalty (Source: LiveWorld team while at Apple and at LiveWorld.)

Ecommerce & Commerce: While only a small factor in the Facebook revenue model today, group shopping is a social behavior that off-line consumers enjoy. Shoppers, both on- and off-line, use social media in increasing numbers to determine purchases, share their shopping experiences, and make recommendations. Social media interaction actually generates an increase in ecommerce. Facebook, being the dominant social media ecosystem, has substantial ecommerce opportunity.

Entertainment: Facebook reports that about 12 percent of current revenue is from its share of game provider revenue on the platform. Video games and many other forms of entertainment are moving online with very strong social dynamics -- again, opening an even greater upside for Facebook.

Facebook Company Value

Where does an ecosystem with a strong usage pattern and a business model that is redefining marketing, insight, service & support, ecommerce, and entertainment take us in terms of stock market value? For simplification purposes, let's say we want Facebook to be worth $100 billion. For a high-tech ecosystem, strong usage pattern company, a reasonable PE ratio is 20x. But since the critics often refer to a 15x multiple, let's go with that, which would require $6.7 billion/year profit to support a $100 billion valuation. Also to be conservative, let's assume Facebook's current 40 percent+ pre-tax profit drops to a respectable 20 percent. This means that the $6.7 billion pre-tax profit is derived from $33 billion in revenue or about 7x their 2011 revenue. This is extra conservative as Facebook enjoys the margin leverage of being the ecosystem, technology, infrastructure and virtually no marketing costs.

Now let's return to the value streams: Facebook achieves $33 billion in revenue on just a 5 percent to 30 percent market share per the above analysis. Actually, if we allow Facebook to have $8 billion in revenue derived from a mix of insight, service & support, ecommerce, and entertainment, that leaves only $25 billion required from the worldwide advertising market, or 4 to 23 percent advertising market share, depending on projections. This is a conservative outlook based on what we know about Facebook's model today. It doesn't factor in the upsides of the innovations neither yet conceived. To look at just an upside, let's assume worldwide advertising grows to $700 billion/year, Facebook expands the social advertising market it works in, further leverages it value streams and the CMOs shift the majority of their spend to social as they say they will do. That scenario could play out to a $350 billion relevant market, Facebook with a 20 percent market share yielding $70 billion/year in revenue. If their profits fall from 40 percent to 25 percent with a 20x multiple (for all this innovation and financial growth), we're looking at $18 billion in profit and a $350 billion market cap.

If we examine and properly understand Facebook on the basis of its ecosystem model, strong usage pattern, growth of the social media market, value derived by Fortune 500 brands, and the intent and actions by CMOs to increase spend, we get a very different picture than the Wall Street critique. Instead, we see a company that delivers high value to consumers and brands, and in turn, will command a high valuation for itself.

Peter Friedman's social media credentials and interest:

  • Credentials: Peter Friedman is the founder and CEO of LiveWorld, a user content management company with a platform and services to scale the human management of social media for large brands. LiveWorld helps Fortune 500 companies protect their brands with moderation, get actionable business insights, and engage their customers for marketing service and support. The company manages over 4,000 Facebook pages, Twitter pages, and community websites for about 100 brands across 25 clients in up to 70 country-language combinations. Peter and the core LiveWorld team members each have over 25 years of experience in driving online community and social media for Fortune 500 brands -- during 16 years as LiveWorld, and 12 prior to that at Apple. At Apple, Peter managed the online and Internet division, a $100 Million+ operating unit that generated marketing, insight, and support ROI. It included Apple's industry social network, AppleLink, eWorld, and the creation of services such as AOL and Salon. Over the last 16 years, LiveWorld has advised hundreds of top brands on their social media strategies and delivered programs that have directly touched hundreds of millions of consumers.
  • Vested Interest: LiveWorld's business is growing rapidly, with a primary focus on the social web -- especially Facebook. LiveWorld has a vested interest in Facebook's continued success. Peter recently purchased 2,600 shares of Facebook stock.

Sources

  1. Over 900 million active Facebook users per month: Facebook S1, 2012
  2. Over 400 million active Facebook users per day: Facebook S1, 2012
  3. 6 hours per month per user on Facebook: Facebook S1, 2012
  4. 100 hours per month per average TV user: New York Times, Feb, 2012 http://www.nytimes.com/2012/02/09/business/media/young-people-are-watching-but-less-often-on-tv.html?_r=1&pagewanted=all
  5. Number of corporations using social media and Facebook is rising: eMarketer
  6. CMOs are universally planning to increase their social media spend while they decrease traditional media spend: CMO Survey, August 2012, CMOsurvey.org
  7. Facebook has the lion's share of this spend: eMarketer http://www.emarketer.com/Article.aspx?R=1009273&ecid=a6506033675d47f881651943c21c5ed4
  8. Ben Elowitz on Ad Age June, 2012 http://m.adage.com/article?articleSection=digitalnext&articleSectionName=DigitalNext&articleid=http%3A%2F%2Fadage.com%2Fdigitalnext%2Fpost%3Farticle_id%3D235708
  9. 2010: 588 billion/year worldwide advertising market: Facebook S1 2012
  10. 2011: $253 billion available market for social advertising. The Social Economy, Unlocking value and productivity through social technologies, McKinsey & Company, July 2012.
http://www.mckinsey.com/insights/mgi/research/technology_and_innovation/the_social_economy
  1. CMOs' project social media spend to grow to 18.8% of marketing spend, CMO Survey, August 2012, CMOsurvey.org
  2. $900 billion to $1.3 trillion as the annual value that can be unlocked by social media. The Social Economy, Unlocking value and productivity through social technologies, McKinsey & Company, July 2012.
http://www.mckinsey.com/insights/mgi/research/technology_and_innovation/the_social_economy
  1. Shift of advertising to 50% social Making Sense Of Social Media 2012, http://www.mckinsey.com/Features/Social_Media
  2. $30 billion market research market with top players at $2-$3 billion each: Siemer & Associates, Fall, 2011 http://www.siemer.com/research/
  3. 2012 American Express Global Customer Service Barometer Study http://about.americanexpress.com/news/pr/2010/barometer.aspx

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