Putting to one side the hype about promoting World Peace by
facilitating better connections between 845 million friends,
particularly cool young ones, Facebook (
) is in the "Selling-Advertising-on-the-Internet-Business." Google
) got there first, so unless the 22-Immutable Laws of Marketing got
revoked, Google will always be #1 and Facebook, who got there
second, will always be #2.
Judging by the number of lawsuits filed against it over its
short history, plus the frequent public apologies for being creepy,
Facebook clearly likes to break the rules. That's good marketing if
you want to appeal to the Pepsi (
) Generation and certainly wearing a hoodie at your IPO Prom plus
taking a public toilet break just so the suits understand who's Big
Day it was ... wasn't rude, it was cool ... awesome even!!
But breaking rules is one thing, breaking laws, particularly one
of the 22-Immutable Laws, is something else. Even on Wall Street,
where they are experts at breaking rules without breaking laws, and
even after Goldman Sachs (
) got away with a hand-slap for flogging the dead-donkey that was
Abacus to dumb investors, there are some laws you can never break
and get away with it.
This was put up eighteen months ago by Facebook (slightly
Facebook has raised $500 million from Goldman Sachs and
a Russian investor in a deal that values the company at $50
billion, according to people involved in the transaction.
The stake by Goldman Sachs, considered one of Wall Street's
savviest investors, signals the increasing might of
Facebook, which has already been bearing down on giants
Leaving aside the ego trip and the thinly-concealed fantasy of
being #1, the bit I liked best was how Goldilocks-The-God-Worker is
"considered" one of Wall Street's savviest investors. Says who? For
me, if Goldman Sachs had anything to do with the valuation, my
instinct says, "run a mile." Oh, and by the way, on the subject of
running a mile, my understanding is that Russian investors of the
undisclosed variety are a lot less relaxed about getting stiffed on
Wall Street than sleepy Norwegian pension funds.
So how do you value Facebook?
Well apart from missing their 2011 earnings target by a mile,
there isn't much on the SEC filing that gives anything to go on for
a valuation except "trust us." But although in retrospect, valuing
) when they went to IPO was tricky - back then what was going to
happen was hard to predict. Valuing Google was a lot easier, and
valuing Facebook is a cinch.
That doesn't mean plenty of different folks haven't got systems
up their sleeves. In that regard, the big "if" right now is if you
pile in and buy Facebook at $30 a share, is that going to double in
That could happen, that's why people buy at IPO; it's like an
auction, you hope to make money for nothing. Nothing wrong with
that, but beware, just like when you sell your ewes at the sale,
you make sure they got a good covering of wool to hide how skinny
they are, sometimes not everything is revealed. Such is the case
here, particularly given the record of the SEC as the adult
supervision making sure no one (Bernie) "Made-Off" with the
But hey! That's business, and the perfectly legitimate job of
the sometimes purveyors of toxic waste, who will be assisting in
the sale, is to work the crowd to create a little madness.
Yet if the process of valuation has any credibility, then a
boring old valuation approach, say for example, International
Valuation Standards ((IVS)), ought to be able to deliver the
"right" answer. If it can't, you might as well just log in to your
Internet Astrologer-Facebook-Friend, and get a reading.
But be careful, the valuation that IVS produces is not the
answer to the results of the auction. That will be simply a measure
of how much madness the promoters managed to create, and for that
your astrologer is infinitely better qualified than any purveyor of
what the boring old-men-in-suits, particularly the ones who go to
Dunkin Donuts (DNKN) (how un-cool is that!) ... maintain is an
"art" ... tempered like a fine sword, by science.
What International Valuation Standards ought to deliver,
reliably, is what they call other than market value; and if two
independent practitioners "skilled at the art" both followed the
proscribed procedures, they both ought to end up with pretty much
the same answer.
That's another word for what un-cool people call the
"fundamental" or "intrinsic value" or what some others call "fair
value." Which should, of course, not be confused with what
accountants call fair value, which is the valuation of crowds
regardless of whether they are suffering from madness or not, and
is sometimes called mark-to-market, as in the price you can sell
something for to someone dumber than you.
The only proviso there is if the crowd is not somehow deemed
"impaired." I won't get into the definition of "impaired" because,
for example, according to the accountants and the banking
regulators, someone who bought a synthetic collateralized debt
obligation in 2008 was NOT impaired, but anyone who didn't, or
wouldn't pay the same price in 2009 ... WAS.
To understand how that works, you have to have dreamed of being
an accountant or a banking regulator from an early age ... as if
that is not a reasonable definition of "impaired" ... but only then
will you truly understand why "profit" as defined by FASB and IASB
is "whatever you want it to be sweetheart." That's cool, eh?
So here's how boring old farts do a valuation:
International Valuation Standards say that to work out other
than market value, you basically have two choices, either
Depreciated Replacement Cost ((DRC)) or Income Capitalization.
For what us experts call DRC, you have to work out how much it
would cost to build another new one, today. That's not really a
practical proposition here because Facebook is unique, they have a
trademark, patents, and they have, as they frequently remind us,
won the hearts and minds of 845 million otherwise intelligent
That means you are left with income capitalization, which
requires two pieces of information; first a discount factor which
ought to bear some resemblance to the yield on a 30-Year Treasury,
taking into account that there is some risk but perhaps not as much
as buying a synthetic collateralized debt obligation lovingly
crafted by you-know-who. That's a call, and there are people who
make that call every day of the week ... take the average and you
ought to be in the ballpark.
The tricky bit is the future income stream. Facebook is not a
start-up Internet company with no revenues, no hope of profit, and
a management team that wakes up drinking champagne (or something
else) while they decide where to fly to today in their private jet
that the impaired-people generously paid for.
Facebook, they got customers!! Those, by the way, are the
advertising and game companies who pay to be "friends" with the
charmed 845 million; but thanks to the customers, they got revenues
too, and holy smoke, they got profits!!
That sounds too normal to be true; even if the business model is
a little creepy, as in: A) making friends with 845 million people,
B) collecting personal details about your friends and then, C)
selling those details to other people.
But there's nothing wrong with that as a business model. When I
was a boy, someone at school made friends with Mildred, and then a
little while later, after they broke up, he started selling copies
of her diary at two-shillings a page. He made a lot of money and
there is nothing wrong with making money, plus the most important
thing was that his customers were very satisfied, which is the main
thing in business.
Of course that model only works until Mildred finds out, and
then she tell her friends and so when you try and pull the same
trick on Samantha, well, she plays a trick on you first.
But let's assume that secretly Mildred was quite happy with the
notoriety she achieved from the distribution of her once private
thoughts. That seems to be the case for Facebook now, and in any
case the information that "gets out" is pretty innocuous.
For example, my daughter spends at least an hour a day on
Facebook, which is longer than she spends painting her nails. I
asked her "what sort of ads do you get?" Well, she lives in Dubai,
she is female of a certain age; so she gets ads about beauty salons
where she can pay someone else to paint her nails, and all of them
are located ... .you guessed it ... in Dubai.
So I asked her "you mean ... you don't get anything about penis
enlargement or Viagra?" She said "Oh, No Dad ... those all come
through to my Hotmail account." So there we have it, the business
model is targeted advertising, and "tasteful" too.
I didn't detect any hint of outrage in my daughter at the
misdirected advertisements she receives via Hotmail or even relief
that she did not receive them via Facebook. Yet in spite of what
Facebook claims about distilling out the essence of what their 845
million friends are interested in, so far my daughter has not
received even ONE ad for ... kite-surfing, quad-biking, or Maui
Thai; which are things her "wall" is plastered with.
You would think that for the $3.73 advertisers spent in 2011
"targeting" my daughter (I don't know who worked out $9.45),
someone might have been employed for ten-seconds to actually LOOK
at her wall.
But clearly the computers at Facebook haven't figured out how to
do that, which may be why they are looking for money so they can
buy some that are that smart. But although it's not on the SEC
filing, I suspect that perhaps Plan-B might involve employing; at
least as an interim step, Third-World-Labor paid $1 an hour to look
at the walls of the 845 million.
How many? Well say 5-minutes per wall, 250 hours a month =
33,000 walls per worker per year after one month's holiday. Divide
that into 845 million and you get a workforce of 25,000 ... add a
bit for expansion, supervision and suicide watch, and let's say you
get to a nice round 30,000.
That's not many, I just read that the company that assembles
iPads for Apple (AAPL) is planning to fire 600,000 workers and
replace them with robots on account of the bad publicity, so that's
good, Facebook should be able to pick up some "cool" ones pretty
Allow for the cost of a computer (not a laptop mind you), plus
Internet access, plus 22 square feet per worker (air-conditioned of
course), toilet breaks, pregnancy checks, drug testing ... etc.,
etc. ... the way I work it out, that's a cost of no more than
$25-cents per wall adding a piddling $225 million or so to the cost
of sales. All I'm wondering is why they didn't do that already? If
I was an advertiser I'd be asking for a good part of my $3.73
Hmm ... perhaps I just revealed how Facebook can make their next
"Great Leap Forward." I shall write to Mr. Zuckerberg and demand he
pay me a billion for that idea; after all, I'm sure it's a better
one than the billion he spent buying that photo sharing company ...
or perhaps that's why he bought it? Or perhaps it's already in the
business plan, after all, Zuckerberg did say he was going to hire
thousands, but perhaps he thought it best not to tell anyone he was
aiming to hire un-cool coolies to look at the walls of the
So what's Targeted Advertising worth?
Well ... what's advertising worth?
It depends on whose numbers you use, and advertising folks are
notoriously bad with numbers; but if you use the same ones over a
period of time ... for consistency, it looks like what is spent on
advertising in developed countries works out, year-in, year-out, on
average, in the range 2.1% to 2.3% of nominal GDP. Nothing
complicated there, it's called "share of pocket."
That's the market Zuckerberg is competing in, the only question
is how much of that he can get into HIS pocket, plus of course how
much it costs him to do that and how quickly he can get his
Today, assuming once the company matures a bit, over 50% or so
of his revenues will come from outside the the USA (like Google),
and no he doesn't say anything about that in his filing to the SEC,
which is an omission he ought to get his hand slapped for because
it's very important, although according to "people involved in the
transaction" 58% of revenues are generated in the the USA now.
By my estimate (based on the PWC audit for IAB), in 2011 total
advertising spent in the USA was about $275 billion. Zuckerberg did
$3.7 billion revenues of which 85% was advertising (the rest was
games, which is low-margin) so if 58% of their revenues are from
the USA, that works out at about 0.7% market share.
One can't help wondering, what's all the fuss about?
Ah you say, but then there is the growth potential ...
Look at Google!!!
Yes indeed, let's look at Google. This is a chart of advertising
revenues in the USA from PWC audits done for IAB comparing
"traditional" ... comprising television (including cable), radio,
newspapers, magazines, and outdoor advertising (but not including
direct mail, Internet, directories and "other") ... compared to
Internet with Google removed, and compared to Google advertising
revenues derived from the USA (half the total). I put in nominal
GDP as the "driver" base-line too, just for fun.
(Click to enlarge)
Notice how in the traditional market there was a bust caused by,
or in sympathy with, the credit crunch and that affected
"traditional" Internet just the same (apart from Google).
The interesting thing there, by the way, is it looks
suspiciously as if advertisers over-spent during the "Golden Days"
of the housing bubble, or perhaps because of it, but now that the
froth has disappeared (no one wants to advertise an apartment to
flip in Las Vegas anymore), you have a typical bust following a
period of what the Austrians call mal-investment
So ... phew!! "All-Systems-Go," everything is perfectly normal
so far, expect traditional advertising to start what that old fart
Ludwig-the-Von called "the tedious process of recovery" ... back to
the long-term fundamental ... anytime soon, in fact it looks like
Internet (outside Google) already started that.
As for Google, well they are clearly on a roll. But it's not
obvious that they are taking very much market share from the
traditional or the Internet sector.
What's not shown on that chart, which is because I can't get a
timeline on the data, is the amount of advertising spent in
"Directories" and "Direct Mail" which added together in 2006
generated $55.7 billion which was about 20% of total advertising
spending, which was pegged by PWC at $285 billion back then (more
I suspect that's the main market that Google is eating
Remember leafing through Yellow Pages? Remember when, if you
were an engineer you used to collect directories and dusty books
with technical data you might need one-day, remember when you
booked a flight or a hotel or a car by going to the travel agent
and asking "what's the best deal you can get me?" That's all out
window, now you just type something in Google, and even if you
can't spell, you have to be a complete moron not to get to what you
want after three tries, maximum.
If you want to buy a lawnmower, you type in "lawnmower" (duh),
and pretty soon you have been bombarded with fifty advertisements
on lawnmowers and you will know more about them than you could
possibly have imagined, did you know some lawnmowers have slug
catchers? Plus you have directions to the nearest ten retailers who
stock them, along with a map and GPS coordinates.
Imagine how likely it would have been that a direct mail flyer
about lawnmowers to have popped through your letter-box the day you
finally decided to buy a new one, imagine if you got ten all on the
So lets look at how that might stack up, given that Google
appears to be big in the boring-old Directories and Direct Mail
space, and Facebook is big in the "cool" space.
(Click to enlarge)
By the way, the total is more than my estimate of about $275
billion, because that's "potential", and as explained above, there
is a bit of a cyclical slump going on right now, in any case, I'm
talking rough numbers. My question is this, which part of that
market segmentation matrix is Facebook proposing to grow market
share, or in other words, which is the "cool" bit?
Remember, Google's model delivers you the information, about
lawnmowers for example, when you want it. Facebook only has the
ability to deliver that information when the coolies (as opposed to
the cool-people) figure you might want it, a bit like all those
un-cool direct mail flyers you had to constantly throw away, before
they invented Google.
Looking at the same thing from another angle, forget about how
much profit Google was making when they went IPO, in start-ups it's
all about revenue, and the point at which your angels cashed out is
irrelevant. Here's the chart:
(Click to enlarge)
OK, you can argue about where the transposed line for Facebook
starts in comparison to Google, but for me it starts when you lift
off the floor, so my second point is that the way I look at it,
Facebook is doing great, but not as great as Google did, and you
have to remember I'm comparing 2005 dollars for Google with 2011
dollars for Facebook.
My third point is that as happens with most things, Google
revenues went up in an "S" curve, it started slow as lift-off
always does, then the low-hanging fruit got picked, and then what's
left is the ones you need a ladder to get to, so then growth
started to slow down ... in 2009 ... and then something happened,
something new, and whoopee she is back galloping across the prairie
like a mustang spooked by a rattler.
What happened is irrelevant, the point here is there was one "S"
curve, then there was another; but we ARE talking "S" curves.
The thing about "S" curves is they often follow the Normal
Probability Function, so perhaps if we fit one of those to the
first four points of Facebook's revenues (including zero other
thereabouts), we can predict the future?
I concede that drawing regression lines through four pieces of
data and then projecting them outside the range of the data is the
sort of thing that I used to get slapped on the side of my head for
doing ... with a ruler (the thin part too), and then I'd get told
to stand in a corner until I almost peed my pants. So I ought to
have learned my lesson, but just for fun ... let's be naughty,
let's break the rules, let's be cool and have a look, I won't tell
if you don't:
(Click to enlarge)
By the way, the R-Squared on those lines with ten points of data
for Google (including zero and going up to where (I reckon) a new
"S" curve started), and four points for Facebook, is 99%, which
doesn't say a lot since there isn't enough data, but it does say
Sure, predicting the next ten years revenues for Facebook, from
three years when they had revenues, is a bit of a stretch.
But Facebook isn't offering any projections even though they got
the Workers-Sent-By-God in their corner, in fact they aren't even
offering any explanation for how they will achieve the projections
they are not telling us about ... apart presumably from the
information that the projection they made in 2010 for revenues in
2011 was 30% too optimistic, and Yahoo (YHOO) is suing their
Here's what I reckon is a reasonable projection for 2016:
(Click to enlarge)
That's another way of re-stating the 22-Immutable Laws of
Marketing written all those years ago by Reis and Trout, who must
both be really old and un-cool by now.
They said that when the market starts to mature #1 typically
ends up with a much bigger share than #2, particularly when #2
doesn't like the idea of being #2 and starts telling customers off
and reminding them he is one of the richest people in the world and
so if they don't like his bad-manners they call all go and f@#K
themselves. I don't know about ladies, but where I was brought up,
that's no way to talk to a customer.
The market cap of Pepsi Cola beverages is one third the size of
the market cap of Coca Cola (KO) beverages. It's always been like
that, and it always will, cool-kids start off drinking Pepsi, then
they grow up and they drink Coke, Coke got to the grown-ups
Oh you say, there are millions more potential friends!! Well, up
to a point, in 2011 there were 2.45 billion Internet users
worldwide, now Facebook has 33% market share, but what they don't
tell you in the one piece of market information they provide in
their filing to the SEC is that the growth in market share is
slowing ... it's reaching the end of its "S" curve, they told you
how many users they had, but they didn't say how much the number of
Internet users had gone up, plot that and you get to the dreaded
Put that another way, a big attraction of Facebook appears to be
lonely people, perhaps the world is running out ... as in
"All the lonely people, where do they all come from?"
That was John Lennon by the way, now he was cool.
Facebook made no meaningful projections about market share,
market segmentation, or revenues for the future in their SEC
filing, here are mine:
(Click to enlarge)
So what's that worth, taking into account that the more you are
uncertain about the future, the higher the discount factor you use
in your calculation to work out the Net Present Value.
Right now Google's market cap is $200 billion, assuming (for the
sake of argument) net profit as a percentage of revenues for
Facebook ends up pretty similar to Google, and assuming (lot of
assumptions), that the market has priced Google correctly. Then if
you use the same inputs to discount forward cash flow that gets you
to $200 billion on Google ... on Facebook, you end up with a
valuation, for today, of $38.2 billion.
But there again, Google is a known entity, for something that is
a little bit better than a start-up with a super-cool CEO, you
increase the discount factor, by say 30%, which gives a valuation
of about $30 billion.
That's my opinion. $35 a share gets you to about $100 billion
market cap, $30 billion market cap gets you about $10 a share, and
so if you are hoping your shares will do a Microsoft and double in
the first year, my advice is don't pay more than $5. Unless of
course Facebook has something else under its hoodie that it isn't
telling us about?
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
Growth Versus Austerity: A U.S. Dollar