Facebook fundamentals: Why its share collapse simply does not matter

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Facebook’s share collapse has the social network’s strongest critics buzzing, some even going as far as questioning the future of the platform. Are we really betting that this is going to be one of the most valuable companies in the world or is this just business as usual in the technology sector: dot.com crash all over again?

By far the most vehement of criticisms comes from Vanity Fair contributing editor and Newser founder Michael Wolff. In an article on MIT site Technology Review, Wolff melodramatically predicts that the social network “…is not only on course to go bust, but will take the rest of the ad-supported Web with it”. Wow.

Wolff does make a valid point in pointing out that Facebook’s forward price-to-earnings (P/E) ratio is outrageously high compared to that of its successful peers, Google and Apple. Facebook is seeing a P/E valuation of over 50, whereas a company like Google is trading at a ratio of around 12. But to not believe these figures is to not believe that Facebook is truly a phenomenon.

As Facebook’s share price continues to slide, the social network’s critics are baying for blood. In fact most early adopters, notoriously fickle, will tell you that Facebook died a long time ago. In their eyes Facebook looks so 2010. Some will even tell you that the future is now Google+ (strangely, most early adopters have yet to write off Twitter — but its time will come too). Early adopters, who hold great influence over thinking on the web, often forget that the rest of the mainstream world don’t so readily get bored with platforms, sticking to what works for them. The reality is that early adopters start to hate technology when it goes mainstream, as it becomes so… so ordinary.

Facebook is now a massively mainstream platform, with about one seventh of the world’s seven or so-billion people on it. And no-one doubts that it has potential to go even larger given its viral effect. To believe in the massive future revenues of Facebook (and therefore believe that its stock price will rise), you need to believe that the social network is something very different and very special from what we have seen in the world.

And when I look at Facebook’s fundamentals, I laugh at the share price everyone is fretting about (now under US$30). I laugh because I know this not about the next couple of months, or even the next year — it’s about the next ten years. So as the share price goes up, down, sideways and via the backdoor — the smart money continues to hold on. It’s a waiting game and I have all the patience in the world.

In confusing times like these, when there is a cacophony of conflicting reports and opinions, I like to go back to the fundamentals. Fundamentals tend to cut through hyperbole and understatement because they are just that: fundamentals.

So here are the fundamentals of Facebook:

  • The social network now boasts almost one-billion registered users, and is the second biggest site in the world, after Google;
  • Facebook has access to detailed demographic data of users that most platforms only dream about, allowing advertisers to match advertising to users’ interests. Advertising often comes across as a nuisance, getting in the way of entertainment or information. The reality is that we actually want to be advertised to if the message is relevant and targeted. I came to this realisation when I found myself poring over the ads in a Wired magazine and I thought “this is unlike me” (I don’t think I have ever looked at advertising in a newspaper). The reality is that it’s a content genre I’m interested in, the ads are relevant and niche, so I look at them. Like Google, and possibly even better than Google, Facebook can target advertising like never before. Suddenly advertising becomes useful, it becomes interesting — and I want it. Who would have thought?
  • Right now closed ecosystems look set to win over the world-wide web as we know it. Why? Well we’re drowning in endless petabytes of digital information and noise. As a filter, social (what our peers and network think) is increasingly winning over the algorithm (what computers think I think). This may of course all change with advances in artificial intelligence and semantic data mining. The pendulum may swing back to the algorithm (read: Google), but we’re a long way off from a computer sensing context and meaning. Social is the best filter we have at the moment for sorting through all the increasing load of digital crap out there.
  • Unlike Groupon, which has had a spectacular fall on the stock market, Facebook is a difficult business to replicate. There are hundreds of thousands of little Groupon clones, some that now possibly do an even better job than Groupon itself, chipping away at what was once an original idea. Facebook, which owns a unique network, is one in a million and difficult to replicate.
  • Monetisation will come, and frankly what’s the rush when you have one of the world’s largest platforms and all the money in the world to play with? Just look at the outrageous revenue success of TenCent in China, a portal-come-Instant Messenger-come-social-network-come-gaming-site. The internet giant has managed to monetise everything from advertising space to freemium services selling Avatars to its users. At the beginning of this quarter TenCent announced US$1.5-billion in revenues, a healthy 21% increase over the last quarter of 2011. Facebook hasn’t touched the areas of monetisation that TenCent has looked at… there is just so much potential.
  • Global advertising will continue to move online. According to Facebook’s roadshow slides, the global advertising market is currently dominated by print (US$138bn) and TV (US$193bn), with online advertising at US$68bn and mobile advertising US$1.5bn. There is a huge print budget for Facebook to tap into as it continues its slow decline. A sidenote: Although dominant for the forseeable future, print will eventually fold.
  • The Microsoft link: let’s not forget the Microsoft connection — that tiny, strategic 1.6% stake. It forces these massive tech giants to think of each other, to occasionally work together and it is an alliance that could be fully activated in the future to take over the world.

We know GM pulled its advertising from Facebook, but then there are also the countless success stories, such as the claim that for every US$1 that the world-famous ice cream Ben & Jerry’s spends on Facebook it gets back US$3 back. The ice cream maker has around about 3.4-million fans on Facebook.

Columnist Larry Magid in an online newspaper somewhere in the world (isn’t it a funny world when you read a foreign newspaper in a foreign country and don’t care where it comes from or what it is about?), summed it up pretty perfectly: “I don’t know what Facebook is worth today, and I don’t care. Because that type of short-term thinking has nothing to do with what it takes to build a great company… When I look at Facebook, I don’t think about price-to-earnings ratio, but of how it’s changed the world for both better and worse, and how nearly a billion Facebook users are using it to enhance their lives and the lives of those they care about.”

Whether Facebook’s ads are performing to their optimum or not or not getting that click-through or this click-through does not concern me. The fundamentals are there, and the company has plenty of time to tweak, innovate and adapt its model. Buying shares in Facebook is a long-term bet on those solid fundamentals. Capiche?

DISCLOSURE: The author owns shares in Facebook. Hat-tip to the Geeklist for giving me the juice to write this article.

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  • http://twitter.com/AliPetersen Alistair Petersen

    Great article Matt. 
    Facebook in its current state is overvalued with that PE ratio, when measured relative to the industry. Google was search, is now advertising and has tried to be almost everything else inbetween (Buzz, Google+, etc.) Apple was a computer company and is now a multimedia channel + device/interface provider. The ethos of success in this industry is evolution and Facebook is primed to start making big changes towards monetisation. 

    Zuckerberg listed the following in the S1 filing with the SEC:
    “We don’t wake up in the morning with the primary goal of making money, but we understand that the best way to achieve our mission is to build a strong and valuable company.”

    Great statement. But when on NASDAQ, do as the NASDAQ’ers do or suffer the consequences of a flailing share price. 

    The reason for listing was given as follows:
    “We’re going public for our employees and our investors. We made a commitment to them when we gave them equity that we’d work hard to make it worth a lot and make it liquid, and this IPO is fulfilling our commitment.”

    And a flailing share price hurts the people with those wonderful options still waiting to be vested or already allocated. Remember that employees of Facebook are not allowed to trade as yet. In fact they aren’t allowed to trade for the first 90 days after listing. Its called the “Lockout Period”. And those employees chomping at the bit to cash in at $38 or more, have lost 25% of their anticipated “winnings” and may lose even more before the final closing of the Lockout Period. What does that do to the psyche of your employees?

    More importantly, when the lockout ends how many more shares will be tradeable on the exchange and will there be a flood of supply matched with a reduction in demand? Lets be clear, Zuck and his investors, NOT employees, have had the luxury of cashing out at $38. Li Ping and Jim Breyer made $2bn from their sales. Microsoft got its intial purchase price of $240m for 32m shares completely refunded from the sale of 6m shares. Zuck made $1bn. Employees…zilch. 

    Facebook is the behemoth of social media but there are many pretenders to the (non-Asian) throne that could take on and usurp the title. Whether it’s a TenCent invasion of the west, a Path that becomes the social destination of choice, or maybe there’s a total shift away to smaller communities of interest instead of doing all your socialising in one place. Having 1 billion users is not the same thing as owning the choice of each and every user about where they want to socialise. Like the diaspora of IM’s – there was one, now there are many – social networks may also develop more choices.

    In its search to grow and deliver value to its shareholders will Facebook push the envelope about what we will and won’t pay for and will they pay the ultimate price for unleashing another Beacon on an unsuspecting, unpaying user base? I’m excited to watch it unfold.  

  • Guest

    Nice article (and b.t.w, I don’t own Facebook shares).

    As an ex-investor I think this dip was more than expected.
    The P/E ratios are telling the analysts to to sell, so let them, there will be many more buyers down the line (its not that they are not there, they just timing it better than others!)

    From my point of view, the advertising model is a very low level monetization method.
    Something I am more interested in seeing unfold is the ‘Big Data’ play.
    Once ‘Big Data’ gathers mainstream acceptance and this area is developed in more detail to make sense of NON-personally identifiable information (on a macro and micro level), well, I don’t think there will be a bigger player than Facebook. We can all speculate but one thing will be sure, the value will be massive!
    Oh, and lets worry about the privacy issues (of aggregating non-identifiable data) when we get there!

    “It’s a waiting game and I have all the patience in the world”…Agreed!

  • Sad_panda

    The Facebook share collapse absolutely does matter. It’s a sign that the market will always tend towards real value.
    The article is right about one thing: fundamentals count. And the fundamentals (not the heavily massaged stats quoted about online advertising) are that you have a company that has a single product based on an increasingly fickle community of users that doesn’t yield returns of traditional companies, and will one day be unfashionable.

    The total defense? It’s a great ad platform and closed system will rule. Bad news – it’s a rubbish ad platform, regardless of anecdotal evidence to the contrary about that time your mum clicked on an ad.

    Closed systems have never prevailed in the mass systems & platforms market. Not once. Every week another hype-driven airhead trumpets about how social media will kill email, and it never does and never will. People always resist lock-in over term, because at some point – in order to thrive – closed systems have to start limiting their users ability to take advantage of a platform. IBM failed with it. Microsoft couldn’t get it right (and they certainly looked the part for many years), Apple won’t get it right (and they are going to try very hard over the next few years) and Facebook is sufficiently inane and intrinsically valueless that there isn’t anything to get right. The moment it becomes even slightly burdensome with targeted delivery, people will just lose interest and move away.

    The term “filter will win over algorithm” is meaningless. We aren’t drowning in petabytes of information. Just because more stuff is stored, doesn’t mean you are any more overwhelmed with information than you were 5 years ago. You choose what and how you wish to consume data (note the word “choose”). And if you feel that the best answer to this statement is to quote that ridiculous presentation that does the rounds every year citing how many quadrigajillions of  messages now get sent every minute compared to 1932, resist it. It’s meaningless to quote stats without context.

    Famous last words – “monetization will come”. Bollocks. Haters gonna hate, money will be be made and lost, platforms and delivery will advance, but the fundamentals will always prevail.

  • OfftheCuff

    I’ve been reading Memeburn for a couple of weeks now and I’ve come to the conclusion that it is Yet Another Blog Written By Amateurs and Bullshitters.

  • http://twitter.com/matthewbuckland matt

    …sorry you feel that way. We take what we do very seriously. It’s obviously difficult to respond to a broad statement like that. Would you like to point out any particular argument in this article or another story that you feel is amateurish or bullshit and we can respond?

  • Pingback: Facebook IPO Small Investors: Is The Stock Market Rigged? | KozMedia News

  • http://twitter.com/luisarriojas Luis Arriojas

    LOL, Now that the facebook’s share price has fallen to 15 dollars per share and its shares suspended, you should be thinking again about this article.

  • Simon Thompson

    **BlackBerry for some reason insists that you install something called
    “BlackBerry link” to get your Z10 and your computer to play nice. By the
    time you’ve gone through the process of “install this, now install
    this” and downloaded the 157MB file, six years have passed. **

    You can get around this like this :
    System Settings, Storage and Access, USB Mass Storage > On
    Then Z10 will act like a USB drive.
    (I turn mine back afterwards, but not sure if it’s necessary…)

  • zaxin

    Great article! As the owner/user of an iPhone 5 and a recently acquired Z10, I can totally relate to your experience. I’m finding it more and more difficult to switch back to the iPhone, which is something I did not expect. If it weren’t for the several apps I need on my iPhone, I’m pretty sure it would become a rarely-used spare. It’s my understanding the next OS update will allow direct installation of Andriod apps, so the writing may be on the wall for my iPhone – lol.
    Btw, I had the same problem with glitchy apps after I installed the OS update. I was able to find out the cause was likely the “settling in” of the updated OS, which takes about a day. Everything has been working great for me ever since.

  • macy

    The app gap will be closed soon.
    I’ve had a Z10 since May and have never had any issues with it. In fact it keeps getting better with each SW update :)

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