Think Facebook's $100 Billion Valuation Is Nuts? Read This
Source: Facebook releases and BI Intelligence Reports
We're all awaiting with bated breath for the Facebook S-1 to drop this week. According to various leaks, Facebook's operating profit was around $1.5 billion in 2011 and its revenues were something like $4 billion. We'll know soon enough whether that's true, but if so, it makes Facebook's reported $85-100 billion valuation sound insane.
This post is written by Business Insider Intelligence analyst Pascal-Emmanuel Gobry. BI Intelligence is Business Insider's internet industry research service. To learn more and get a free 30-day trial, click here.
Is it?
Well, anyone can argue that it's high. But we don't think it's insane.
First of all, the value of an asset is the net present value of its future cashflows. This means that a company's value doesn't depend on how much revenue it generates today, but on the profits it's going to generate in the future. The value of the current financials is in helping someone figure out what are going to be the future financials. That's more of an art than a science, obviously. But we have to remember that assessing whether a valuation is insane is about assessing the future of an asset.
So, what's Facebook's future like? It's very bright.
The basic reasoning behind Facebook's valuation goes something like this: every new technology cycle is dominated by one company, and that company usually ends up being worth around $200 billion. Microsoft dominated the PC era, and Google dominated the search era. Facebook is going to dominate the social era, and therefore it's going to be worth $200 billion some day. Discount that to today and $100 billion looks like a steal.
But how likely is it? There's no question Facebook is a big business worth many billions of dollars, but can it be one of those epoch-defining companies a la Google and Microsoft? There's no way to know for sure, but here are some high-level reasons why it's not insane to think so:
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Facebook is becoming one of the biggest sources and referrers of traffic on the internet—and on the internet traffic is money. The reason why Google became the most valuable and feared internet company was because most of the traffic on the internet came from Google. This is changing. An increasing amount of traffic—for some sites, most of their traffic—comes from Facebook. And on the internet, traffic is money, because it translates into (take your pick) advertising, commerce, transactions. If Facebook controls half of the traffic on the internet (as it does now to many sites), it can start selling that traffic very profitably. (This is also the real reason why Google is terrified of Facebook, even though they're not direct competitors.)
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Facebook has oodles of data on you, including your identity. The web has been crying out for a personal identity system: a way to link transactions and traffic to a real-world identity. Facebook is the first site that has achieved the goal of getting us to identify using our real-world identities. The opportunities for targeting advertising are obvious, but they are much broader: By "owning" personal identity on the internet, Facebook has an immensely valuable asset.
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Facebook is the biggest social platform. "Social" is a fad, some say. We disagree: What "social" means is that people decide what to consume and share among other people, which is the natural way to do things. "Social" is always going to be a part of consumer and even enterprise applications. And Facebook, intelligently, isn't content with being the biggest "social" destination site; it has turned itself into a platform, allowing others to either build applications on top of it, or use its tools to add its "social sauce" to its system. Just as Microsoft dominated the computing world by owning the biggest software platform—Windows—Facebook is turning itself into the dominant platform of a new internet era. (It might not end that way, but it's definitely not a silly case to make.)
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Facebook is unstoppable because it has a network effect. We are mixed on this, as we have written many times that network effects are oversold. This is what we think about Facebook's network effect: It does ensure that the vast majority of people on the internet will be Facebook users, and that this in turn will make Facebook's platform very valuable. What it does not ensure is that Facebook will always remain relevant and might not be displaced by other platforms. But not everyone sees it that way.