Tuesday, December 28, 2010

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Monetizing the Social Effect

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A look at Facebook's valuation and expected IPO, including an interview with Neil Bearse.

(Interview transcript attached at end of article.)

In The Social Network, a film about Facebook’s rise, founder and CEO Mark Zuckerberg is presented as a shallow, yet brilliant inventor. The Social Network has been at the top of the box office charts since its release, a clear indication of the general public’s interest in the social media behemoth. Besides theatre audiences, the interests of potential investors have recently been piqued as a result of rumours of a Facebook IPO in the near future.

On July 30th, 2010, Facebook announced that it would delay its IPO until 2012. This was confirmed late September by board member Peter Theil, co-founder of Pay-Pal. He explained that Facebook will launch an IPO only when it has met its revenue targets. Bloomberg also confirmed this with three anonymous sources, citing that Facebook will launch an IPO at a later date.

Despite all the movie buzz and public offering speculation, there is a bigger question that should be asked: does investing in Facebook make sense in today’s markets? To answer this, several factors need to be considered.

Valuation of the Online Marketing Industry

Facebook, Twitter, LinkedIn, MySpace, and Friendster all share the same business model of selling ad space online. Their business model, perhaps best explained by Chris Anderson in his book Free: The Future of a Radical Price, is an indirect model of offering free content to users while receiving revenue streams from entities interested in marketing to those users.

The online marketing industry is estimated to be US$707 billion worldwide by 2012, at an annual growth rate of 2.7%. In Canada, the size of the market is estimated to be US$3.3 billion by 2012, a 21.3% increase from 2007 at US$1.3 billion. Facebook, according to insiders, generated revenues of US$800 million this year. These numbers reflect a growing industry, and many large brands are using social media outlets like Facebook to attract new customers. This is more than likely to continue.

Facebook has attracted some of the largest brands in the world to advertise on its site. This list includes Nike, Coca-Cola, and Starbucks. Starbucks alone has generated over 3.7 million fans on its page. For advertisers, the social network offers the world’s largest platform to advertise: 500 million active users, most visits compared to any other website, and an average visit time of one hour.

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The Facebook Business Model

Facebook’s success is based on innovation. Being compared to Steve Jobs, Zuckerberg is now a prominent leader in Silicon Valley, at the age of 26.

In 2009, 99% of investment went into the development of Facebook Applications. Farmville, created by Zynga, is the most popular application on Facebook, with 62 million users—that is 10% of users on Facebook. Zynga’s revenue is estimated to be $270 million in 2009.

Facebook aims this year to create custom experiences for fans and start a payment architecture for custom applications: selling virtual items through these applications. This provides yet another revenue stream for Facebook besides selling advertisement space.

With the ingenuity within the offices of Palo Alto, California is a seemingly unbeatable force. It has created some of the most innovative and powerful tools for individuals and businesses alike. Facebook Connect, an API that allows Facebook users to log into third party websites, has spread the brand of Facebook beyond its own borders. DayOnBay uses Facebook Connect at the bottom of this page. Feel free to “Like” or comment below.

Risks

In order for Facebook to proceed with an IPO and face the public scrutiny that accompanies it, Facebook will have to face three major challenges: privacy concerns, new competition, and lack of management experience.

The ongoing privacy concerns surrounding Facebook creates the risk of class-action lawsuits and government regulations against the company. Obama has called on everyone to be prudent when using the site, and Canada’s Privacy Commissioner Jennifer Stoddart said she needs to conduct another review due to Facebook’s additional features. Yet the controversy over privacy has not stopped consumers from signing up on Facebook. Users have embraced the fact that information about themselves will be available to others and consider the benefits of using Facebook more valuable. This means there is a continued network of consumers who are willing to use Facebook’s many applications, while being exposed to advertisements and corporate fan pages.

When Facebook first started, MySpace and Friendter were its only competitors. Facebook triumphed over these sites by providing a website for the purpose of connecting people. It created a network effect: creating value that depends on the number of customers by offering a product at no cost and free of advertisements. Not until November 2007 did Facebook start adding ads onto its site. By that time, it had well over 20 million users. In addition, Facebook is a company of ongoing research and development. It has a proven history of creating the next online hype from its initial “status update” to the “Like” button. With more than 500 online accounts and growing, it has not only overtaken its competitors’ market share, but also secured an incredibly strong customer base that causes huge barriers for new competitors.

Some analysts believe that Mark Zuckerberg is not capable of running a company because of his lack of managerial experience. Zuckerberg and his management team have made mistakes while running the company (i.e., concerns over personal privacy), but Facebook’s massive success is also attributed to him. Deciding not to sell ads on Facebook until it was more established and creating features that people love to use shows a person who understands how to run a business. Facebook has the confidence of the biggest players in Silicon Valley. For example, Microsoft invested $250 million in the company for a mere 1.6% stake.

Rampant Speculation over Facebook Valuation

Facebook is shy on releasing how much the company makes and is worth. Forbes thinks Facebook is worth $23 billion, SharesPost $26.3 billion, and The Financial Times $33 billion. These conflicting valuations are all unreliable because no one really knows until Facebook, a private company, becomes public.

All indicators point to Facebook as a good investment, even in 2012. The exponential growth of new accounts only means greater opportunities for revenue generation. Knowing what Facebook is capable of doing, one can predict it will define a whole new market of advertising and selling goods and services over a social network. This makes it so much easier to click “Like” on Facebook.

What do you think? Would you invest in Facebook? Will Facebook continue to grow in the future?

 

Investing in Social Media Companies Transcript: Neil Bearse - Manager of Web-Based Marketing, Queen's School of Business

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Further Reading

The Facebook Story

The 2010 Digital Marketing Industry Report

Nothing on this web site should be interpreted as a buy, sell or hold or other investment recommendation. Visitors are strongly urged to consult with a qualified financial advisor before making any investment decision. No person involved with the running of this website can be held responsible for any investment decisions made by our visitors.

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