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The Facebook Bubble


CR
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looks like people have short memories. This is looking a lot like 1997-98-99 for tech companies again. Sky is the limit and all that. Look at NFLX, AAPL and this. History will repeat.

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I dont think people have forgotten the dot-com bubble... they want it to happen again to try to make money and sell early.... although most people wont.

ARM in the UK is trading on a PE of around 100.

There is always the next bubble....

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Alot of tech stocks are trading at huge multiples of book right now.  Nothing like the tech wreck era, but definitely inflated.  The $50B valuation on Facebook gives it a earnings multiple of 100 and a price to revenue of 33.  Cheers!

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Prem Watsa always takes time in his annuals to point out the significant bubbles of the day -- housing in 2006, tech/media/telecom in 2000.  He has a few to choose from for the 2010 annual.  Will it be gold/commodities bubble or the reflating tech bubble?

 

-O

Alot of tech stocks are trading at huge multiples of book right now.  Nothing like the tech wreck era, but definitely inflated.  The $50B valuation on Facebook gives it a earnings multiple of 100 and a price to revenue of 33.  Cheers!

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I know netflix at 10 billion is overvalued but they get less than 1% of the worlds traffic while Facebook's 50 billion price tag is a lot I'm not so sure that the 2nd most popular website in the world with nearly 40% of all traffic is that grossly expensive.  Getting them to show your ads is actually quite expensive and will probably become more so as more advertisers bid for traffic, I had to bid around 1.5$ per click to get my ad shown to a targeted local audience. 

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While I agree that Facebook is way overvalued, I also think people don't fully understand its potential.

 

Facebook wants to subsume as much of the web at it can. They  as much of the

activities you perform currently on other locations to be inside Facebook. Eg, games, invites, email, Q&A, etc.

Once they have you inside, they have many ways to monetizing your activity, advertising being just one. Eg,Facebook

credits allows them to be the billing system and take a cut of any transaction that happens on the site.

 

This is the exact opposite of Google. Google dominates the monetization of the open web through advertising.

They are trying other methods like Google checkout but have met with little success.

 

Once that traffic or activity goes to Facebook, Google has no way of monetizing it. Advertisers flock to FB with their

dollars cutting into Google's bread and butter. You are already seeing Google making noises about how FB is fragmenting

the web.

 

Now, what is the valuation of a company that is likely to be a "mini-web" in itself?

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I am pretty sure everyone understands that the walled garden / internet country / itunesModel is what facebook wants to do and is actively trying to do and that is why the valuation is so high.

 

My point wasn't about facebook. It is likely that it is worth some # between and 50B and the 200B that google trades for. My point was more about the bubble around facebook, e.g. STVI, Zynga, etc.

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^^^^^^^^^^^^^^

 

CR, not quite, see above.  ;)

 

If you believe that FB is worth more than $50B, that makes them undervalued.  ;D

As for the others, its not clear what their financials are. I have heard rumors of

Groupon revenues being anywhere from $500M to $2B. They look a lot cheaper than FB to me.

 

These are private companies that prioritize metrics like customer/traffic acquistion over revenue or profits.

If they were to go public, their financials will look very different. They will pay attention to revenues and income on a

quarter by quarter basis. Does it make sense to value them on a revenue/profit multiple similar to public companies?

 

My gut tells me that they are overvalued. But I know I am just making a guess. These are companies that are evolving

their business models as we speak. 

 

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Purchasing equity in facebook at 25x revenue, where the business model is not entirely clear, seems to fit perfectly with Ben Graham's definition of a speculation.  An investment offers safety of principal based on the facts.  Now, it might turn out to be an incredibly intelligent speculation or it could be another AOL.  I'm not smart enough to predict that far into the future, but it seems difficult to draw conclusions today based upon the facts.

 

While there is a huge group of people who use facebook each day, I still can't get past the basic difference in the value proposition offered to advertisers compared to google.  At the core, facebook offers the most targeted banner ads ever devised but they are still just that - banner ads.  Compare that to google, where you have an active searcher seeking information about a product or service.  As an advertiser, I'd be willing to pay a higher price for that point of sale remider so to speak then a banner ad generated to match my interests. 

 

 

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If they could make $5 per user and year, they would make $2.5b a year. Now, making $5 a year on each user doesn't seem wholly unreasonable in my view, albeit those figures won't be made in the very near future. Also, I don't see any near-time cap in user base. 1b in 5-10 years is not a bold guess, and to me, although I'm a highly modest user, the model seems too sticky to go away. Of course, this doesn't fit any value parameters whatsoever. I'm just saying that this is quite different to Yahoo at 100x earnings some 10 years ago.

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Purchasing equity in facebook at 25x revenue, where the business model is not entirely clear, seems to fit perfectly with Ben Graham's definition of a speculation.  An investment offers safety of principal based on the facts.  Now, it might turn out to be an incredibly intelligent speculation or it could be another AOL.  I'm not smart enough to predict that far into the future, but it seems difficult to draw conclusions today based upon the facts.

 

While there is a huge group of people who use facebook each day, I still can't get past the basic difference in the value proposition offered to advertisers compared to google.  At the core, facebook offers the most targeted banner ads ever devised but they are still just that - banner ads.  Compare that to google, where you have an active searcher seeking information about a product or service.   As an advertiser, I'd be willing to pay a higher price for that point of sale remider so to speak then a banner ad generated to match my interests. 

 

 

 

Its not only your interests but your age, sex, education, location etc...and like google they can just give away limited free advertising and increase the amount everyone has to bid.

Google can do a lot of interesting things with Youtube which in hindsight almost seems like theft at a mere 1.5 billion.

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oldye, you are correct.  FB's banner ads can be tailored for all of the characteristics you state.  My main point is that google offers an advertiser the opportunity to have their product or service showcased at the time a user is actively seeking information about such an item, whereas a banner ad is more akin to a highly tailored newspaper advertisement.  Great to get your message in front of the right folks, but not as good as getting your message to them when they are seeking out information or, better yet, about to make a purchase.  I cannot find the article right now, but I've read that the it rates on FB ads are far lower than Google.

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Is there a network effect?

 

Facebook's moat is enormous. You could argue that it's bigger than Google's moat.

 

Yes, there's a huge network effect. Facebook is a social network. The more people who join Facebook, the more people there are who want to join Facebook. That's the definition of network effect. If you are under 35 and living in NA, almost everyone you know is now on Facebook. So it's hard to imagine why you'd ever want to join another social network where none of your friends, family, and business contacts are.

 

Beyond the network effect, there are also switching costs. Facebook has your photos, profile info, interests, and (for many people now) your email. If you are under 25, FB is probably your primary means of day-to-day communication with other people. Think about what that means. For many users, leaving FB for a competitor would far more painful than switching banks. Losing access to FB would be like losing access to their phone.

 

Once it is making $5 per customer per year and neting $5 billion I am sure that there will be competitors coming out of the woodwork. What would stop Google or other competitors?

 

Competitors have been coming out of the woodwork for years. Google has already tried and failed several times to build its own social network. It found success in Brazil and Estonia with Orkut (because it got there before FB and leveraged the network effect to build its own moat) but nowhere else. The latest attempt was Google Buzz. The fact that you've probably never heard of either of these is a good indicator of how successful they've been in taking on FB.

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oldye, you are correct.  FB's banner ads can be tailored for all of the characteristics you state.  My main point is that google offers an advertiser the opportunity to have their product or service showcased at the time a user is actively seeking information about such an item, whereas a banner ad is more akin to a highly tailored newspaper advertisement.  Great to get your message in front of the right folks, but not as good as getting your message to them when they are seeking out information or, better yet, about to make a purchase.  I cannot find the article right now, but I've read that the it rates on FB ads are far lower than Google.

 

You're right that search engine ads generally perform better, both in terms of click-through-rates (CTR) and conversion rates, than display (banner) ads. An ad's CTR measures the % of people who see the ad that click on it. The conversion rate measures the % of people who click on the ad that go on to purchase or signup for whatever is being advertised.

 

However, one limitation with search engine ads is that they often can't generate meaningful amounts of traffic for a really niche product or really new product or service. With these types of products, it's possible that nobody will be searching for it. They have to be aware of it first.

 

With Facebook, however, I know I can get my ad in front of pretty much all of my target customers who are online. And man, can I ever target my customer! I can define my target in terms of gender, age, location (right down to the city), language, personal interests (e.g. people who like model trains), relationship status, and social connections. And if 99.99% of them choose not to click on my ad, that's no skin off my nose. I only pay FB for the ones who do click.

 

From Google or FB's perspective, the revenue equation is very simple. Revenue = Traffic x CTR x Cost per Click. Google wins on CTR and CPC. The CPC is higher because clicks from Google are worth more to advertisers due to higher conversion rates. And when Google shows an ad, it gets more clicks than when FB shows it (higher CTR). The last variable is traffic. About 10 months ago, Facebook overtook Google in terms of traffic, and its growth rate is still much higher.

 

Another thing to note is that advertising is just one revenue stream on Facebook. The other really big opportunity is Facebook Credits, which will effectively give Facebook a 30% cut of all the gaming revenue that's currently going to companies like Zynga and Electronic Arts. 

 

Finally, please don't take any of this as an endorsement of FB's current valuation. I have no idea what the company is worth and I'm sure any conservative estimate I came up with would be far below what others are currently willing to pay. So I'm not saying FB is a good investment, just that it's a great company.

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People were saying the same things about MySpace a couple of years ago.

Last time I looked Rupert was trying to sell it.

 

I see what you're saying, but I would argue that things have changed dramatically in just a few years. When Fox bought MySpace in 2005, MySpace had nowhere near the moat that Facebook has now. MySpace and FB were still slugging it out for users, and both were growing like crazy, but neither of them had the critical mass to make the competition irrelevant. In 2005, everyone I knew was not on MySpace. Deciding which social network to join (or whether to join any of them) was actually a decision. People were excited about MySpace's historic growth, but Fox failed to realize that MySpace was still one of several companies (remember Friendster?) in a winner-takes-all race, and it was too early to pick the winner.

 

Today, the race is over. Facebook won, and everyone else died. FB now has the critical mass to make any entry into this space so expensive that even companies like Google and Microsoft are struggling.

 

I don't think you can compare MySpace or Facebook in 2005 to Facebook in 2011. It's a bit like saying "American Express came out of nowhere to kill Diner's Club in the 1960s, so what's to stop some new company from taking out Amex now?"

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Beyond the network effect, there are also switching costs. Facebook has your photos, profile info, interests, and (for many people now) your email. If you are under 25, FB is probably your primary means of day-to-day communication with other people. Think about what that means. For many users, leaving FB for a competitor would far more painful than switching banks. Losing access to FB would be like losing access to their phone.

 

Switching costs, to me, will expose Facebook to antitrust scrutiny, especially after they go public.  Facebook is notorious already for doing "one way" imports of data without giving any good way of getting your information back out.  I haven't put anything in Facebook that I don't consider public information, and privacy issues will prevent me from ever doing so.  Even more scary is that your privacy is no longer in your control--your friends have the ability to expose massive amounts of your private information, so choose your friends carefully.

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