Facebook Is A Solid Investment Despite The Few Myths Out There

avatar By: IS
Date posted: 08.31.2011 (5:00 am) | Write a Comment  (2 Comments)

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It’s no surprise, I’m a big believer in Facebook, its future not just as a company and service but also as a business and in the fact that its current valuation of $100B or so, seen as outrageous by some is actually a bargain. I had an interesting discussion with Bret in the comment section of a recent post as he disagreed with the notion that Facebook was a solid business. His main argument was that Facebook was not diversified enough and mentioned his post about 4 investing lessons (not only is Bret a great and interesting commenter on here but he does have his own blog). Today I will answer that argument not only for Bret but all of the others that doubt Facebook’s value.

Myth #1 – Facebook Is A One Trick Pony: Interesting that Facebook is now being accused of that as up until recently, that was one of the main points of criticism regarding Google. First off, contrary to popular belief, Facebook has revenues from 2 very different sources. There is advertising of course (more on that later) but also credits. Increasingly, transactions are occurring through Facebook. It started as a “tax” on gaming apps such as Zynga’s but as more companies start to plan transactional features on Facebook, the credits part becomes an increasingly attractive business. Facebook credits are a virtual currency that makes it easier for users to spend online. They can give their credit card info to one party (Facebook) and then use acquired credits to buy other items. Facebook charges 30% to merchants and is making hundreds of millions per year through this.

Myth #2 – Facebook’s Advertising Revenues Could “Go Away”: Just this week, Facebook started offering advertisers the option of targeting by zip code, city and state as well as by all of the existing methods (job, school, interests, etc). Facebook and Google are by far the two companies that have the most knowledge about internet users and in the advertising world, that is incredibly valuable.

Myth #3 – Facebook Will Fade Away: I’m not saying that it will not happen eventually. However, after seeing Google come up with a product that was so well designed (Google+) and using its powerful network to promote it, I was one of those who said that Google did have a shot at competing with Facebook. A few weeks later, Google already seems to have lost its momentum and while it has tens of millions of users already, they are spending little time on Google+ making it even more clear that competing with Facebook will be a tremendously difficult task. Also, just think about all of those companies such as Coca-Cola and Nike that are spending millions promoting their Facebook pages. Do you think they would do so if they believed that it might be declining or that the risk was significant?

Myth #4 – Revenues Will Not Flow To Facebook: Over the last century, advertising dollars have always followed users from newspapers, magazines, radio, television and now the internet. Facebook is already making billions in revenues, has the most used service on the internet where users spend more time than anywhere else.  That will continue to translate into revenues

Myth #5 – This Is Another Dot Com Bubble: While some companies such as Pandora (P) remind me of that period with no profits and no clear plan to profitability, companies such as Facebook have been profitable for years and those margins are increasing constantly. Are valuations out of hand? I personally do not think so in most cases.

Is Facebook a sure thing? No, of course not. Few young technology companies are. But I would say that Facebook will be much more difficult to compete with than anyone else except for Google which is part of the reason why I think the risks involved are overblown.

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2 Comments

  1. Comment by Value Indexer — August 31, 2011 @ 8:56 am
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    Those are fair points – the detractors of Facebook as an investment sometimes don’t have any more logic than the blind bubble-chasers. What strategies do you think Facebook could successfully deploy to achieve a level of profitability that makes it one of the most valuable companies in the world?

    It definitely has some strengths and draws an easy comparison to Google. With a game-changing presence and advertising revenue it could even grow along a similar path (I think it started 6-7 years later). But you also need to look at whether it has a similar culture to Google that’s likely to produce that kind of results. Al blog post I recently read from the hiring perspective mentioned that while Facebook has a lot of smart engineers, many that this person had encountered aren’t good at working together.

    I would also look very closely at the sustainability of a 30% tax on transactions. That works if you’re delivering a lot of extra value, but as soon as a company thinks they can keep up their income without your help they’ll seek alternatives. Many businesses will go to great lengths to save 1% on transactions.

    There’s potential for sure, but RCA and Reynolds Aluminum (as I discovered this week) were once “the new thing that’s taking over the world”. And the world’s fastest growing business is now looking like it may not be able to sustain itself long enough to go public as profit margins come under attack. I like my investments to have a strong “old, boring, and profitable” flavor :)

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    [...] is a critical part of Google’s future and one where it will compete with companies such as Facebook, Yahoo and Yelp among others. There will be many challenges but Google is already in a great [...]

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