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Facebook fundamentals: Why its share collapse simply does not matter

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?

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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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