Wednesday, February 29, 2012

The Big Facebook Revenue Yawn.

Yeah. Facebook is IPOing. The words of one of my mentors sum it up best: "meh."

The stock will (initially) go up...
Morgan Stanley, Goldman Sachs and other Wall Street friends will undoubtedly have pre-sold enough shares (to quasi-informed dentists and doctors who want to be part of the "next big thing") to make sure that the stock goes up at IPO time (See a really interesting post on a related topic here: Today, I'm going to make a back-of-the-envelope case here that the revenue side of Facebook ain't anything to get anybody excited about. When reality sets in, I'll bet that the stock heads south.

Some pretty good margins and unrealistic expectations for growth

The Wall Street Journal reports that in 2011 Facebook had revenues of about $3.71 billion and profits of about $1 billion. That's about 26% margins. Not bad at all. But with a $75-100 billion dollar IPO valuation, Facebook would be priced at 75 times trailing earnings and about 20 times sales. In other words, there are massive expectations for revenue and profit growth. Where does this revenue come from?

There are predominantly 4 main streams:

1. Advertising
2. Marketplace
3. Sentiment analysis for companies.
4. Revenue shares from Zynga Farmville type applications.

Advertising constitutes the biggest chunk of Facebook revenue. But how much growth is in advertising for Facebook? Not a lot for two reasons. First the Facebook user base is not going to grow much more and secondly, there are much better vehicles out there for brand builders.

The audience size is already factored in
Let's go to the first point. Facebook has 850 million users. That's tremendous. But lion's share of global Facebook accounts has already been had and it is unlikely that high growth will come from new Facebook accounts. More certainly, the consumers with the most desirable income levels (which is important for advertisers) already have accounts. All of this to say, that advertisers have already absorbed/reflected on Facebook's audience size/desirability and have signaled how good Facebook is as an advertising/brand building vehicle. That amount is $1.9 billion. But, its hard to see how user growth factors can support the 8X or 10X ad revenues (and profits) that Facebook needs to support its proposed $75-100 billion valuation.

But wait a minute- perhaps Facebook users will spend more and more time on Facebook - giving advertisers better advertising opportunities. Evidence here suggests the opposite. Most users are most active when they first activate their accounts- adding friends, tagging pictures of themselves with their crush, or confirming Aunt Edna is their aunt. After that, the usage curve (for most) drops off and Facebook's functionality increasingly is geared towards messaging friends.

Facebook came in 2nd in a advertising beauty prize, here is $10.
Second, as Facebook heads more into the advertising world, it increasingly competes for advertising dollars with Google. But, what is a better venue for advertisers? If you were an advertiser selling wedding dresses in Idaho, where would would you rather target your ad:
A) On Facebook where a young woman who changes her status update from "in a relationship" to "engaged" or
B) On Google where the same young woman enters a key word search "wedding dresses in Boise"?

Google (and other online sites), simply has a better venue for targeted advertising- and that's what advertisers want. Facebook may have some excellent brand building opportunities via social networking (which is more viral but doesn't deliver advertising revenue) but it is clearly in a lower tier for generating ad revenues. Facebook's runner-up position in advertising reminds me of the old Community Chest Card on Monopoly.

Facebook's plans call for growing a classified sales in its Marketplace. This puts Facebook in Craig's List's domain. But here's the question: If I have an old table to sell, where do I have a better chance selling it - among my group of friends (or network of friends' friends) or via the site dedicated of bringing a much larger group of buyers and sellers together? For most items, Craig's List (or the online version of the local newspaper) gets the nod. There's revenue in the Marketplace for Facebook, but its not going to dominate the online classified section anytime soon.

Sentiment Analysis
One of my academic research involves how managers measure their brands. One of the findings is how managers are increasingly measuring their brands online- and how they should be (so many do it wrong). Some brand managers track how many Facebook users "like" their brand. Others perform Internet sentiment analysis. These are important additions to a manager's metric tool box. But, is there really a lot of revenue out there for Facebook in this domain when there are dozens of free sentiment analysis tools like Rankspeed, Twendz, and TwitterSentiment out there?

As an aside, I did some Twitter sentiment analysis on Facebook today. The online sentiments about Facebook are pretty much evenly split between positive and negatives. That ain't too good.

Revenue Shares
Farmville was a revenue bonanza for Facebook. According to the Facebook financials, revenue share from the game's transactions represented around 13% for Facebook. But will Facebook be able to replicate successes like this? So far no other application has been anywhere close to capturing the imagination of the maturing Facebook users like Farmville did. The fear is that the Farmville-type revenue stream may be closer to a one-hit wonder than a reliable ongoing revenue stream.

The point of this blog is not to trash Facebook. Facebook is a strong brand that has had amazing growth and a fascinating history. Even if a small percentage of 850 million users are lovers of the brand (Brand Mojo ratings on Facebook show that about 13% of respondents love the brand), Facebook will play a powerful role in shaping the online world in the foreseeable future. But when you break down the revenue side of Facebook's business, it doesn't look very exciting- certainly not at the level that deserves a market capitalization greater than Disney's or equivalent to McDonald's or Pepsi. When reality sets in, I'm betting most of the doctors and dentists will be wishing that they didn't buy the stock.


  1. Hey Bob, its true how facebook usage falls down over time.I only log on to wish acquaintances happy birthday now- and keep in touch with friends who moved away. I also notice how when my friends get in relationships, they drop off facebook too.

  2. So Farmville generated about $400million in revenue for facebook? That is insane. I no longer get any of those annoying requests about joining the farm. I wonder if that means no one is playing it anymore.

  3. Bob,
    Excellent post. I agree with much of your analysis and join the sentiment that this is lavishly overvalued. My biggest issue comes down to 2 old school metrics of business. Threat of new entrants and switching costs.

    1) I will almost guarantee that someone will come up with nice tweaks to FB and make it more desireable, so simply create something much better.

    2) What does it take for people to sign on to the new social media site... 5 mins. Sure everyone is on now and using it a lot, but individuals and companies can set up shop elsewhere really quickly and FB can lose their core business stream overnight. (to your point, definitely not similar to McD's or Disney!). If a critical mass switches, there can quickly be a mass exodus.

    Either way, FB may keep 850B users, but time online will drop off a cliff sending the Ad business into a dramatic decline (or at least little to no growth). i would stay away from the FB IPO like the plague. When (not if) they become not so cool, its over and maybe Amazon will just buy them.