Today Inside Facebook posted a brief article about the slowing growth of Facebook. Surely most companies could only dream of having the nearly 700 million users it currently has, and any extra is a bonus. However, with valuations of up to US$70 billion, Facebook has high expectations to live up to. Facebook’s valuation is tied to expectations of its future growth, which I will explain further in this post.
How should we find the right price for a company?
A good way to find a reasonable price for a company is to look at the price to earnings ratio (P/E). If a company is valued at $10 million and the company earns $1 million per year, it has a price to earnings ratio of 10. If you look at the historical averages of the Australian share market (and many other share markets), a P/E of about 17 seems to be the norm. So in most scenarios, a company earning $1 million should be valued at $17 million. Of course this is an average and will change depending on whether the market thinks we are moving into or coming out of a recession.
Tech businesses can generally obtain higher valuations than traditional industries because tech businesses can scale much more quickly. You need to write the software once, but if your user base increases by 20%, you only need to buy a few more computers. When choosing a company to invest in today, we want to know what it will earn tomorrow, not what it earnt yesterday. So rather than using the price to earnings ratio of prior earnings, investors price companies on future earnings, if they know what they are.
This is where growth becomes important. At a valuation of US$70 billion, you would expect a company to be earning about US$4.1 billion, or in Facebook’s case about $5.80 per user per year (this should take into account the cost of running the service). For the overwhelming majority of users, Facebook earns its money through advertising. That’s a lot of advertising dollars (especially considering that Facebook advertising is significantly lower earning than other display and search advertising).
However the growth rate, not the total number of current users, is what the current valuations of Facebook are based on. Facebook is valued much more highly because investors believe in a year’s time there will be many more people using Facebook than there is right now. My belief is that there are not very many people left in the world who either haven’t heard about Facebook or have heard and will be convinced to join in the future. But belief is one thing and statistics is another. So I used a couple of free online tools to work this out: Google Trends and Alexa.
Facebook Growth Statistics: Search
First port of call is Google Trends. Using it I produced this graph below:
I noticed this trend while doing some research for my previous article on Google Correlate. The trend shows that the number of searches for ‘Facebook’ has stabilised. This does not, however, directly indicate the traffic to Facebook. Many people type ‘facebook.com’ into their address bar or have Facebook set as their home page if they are avid users and hence do not search via Google for Facebook. However there are a large number of people who search even for the sites that they visit regularly. What it does show, in my opinion, is that the mystic aura of Facebook is fading. No longer is Facebook something that people have to search Google for to find out about. It indicates that the number of new people wanting to join Facebook isn’t really increasing. So for current investors in Facebook, the number of new sign-ups can be (at best) expected to continue at the current pace.
Facebook Growth Statistics: Unique visitors
Google Trends has another “Sites” feature that allows you to view the number of unique daily visitors to sites that you specify. Type in ‘facebook.com’ and you get the following:
This shows that the number of unique daily visitors is decreasing. So not only is Facebook struggling to increase new users, but it is also losing current users, either through disgust at Facebook’s ever changing privacy policies, or simply (and more probably) through boredom. This trend is especially apparent in the top 3 countries in which Facebook is popular:
I was a little hesitant to rely simply on Google statistics, so I used Alexa to determine the daily reach, which is determined to be the number of people who visit the site who have the Alexa Toolbar installed in their browser. In comparison to Google, I consider Alexa to be a poorer source of information because the samples for the statistics are users who have installed the Alexa toolbar (either by choice or it being part of another installation process). It also samples from people who use older browsers as newer operating systems tend to consider it to be malware. I chose to include it anyway because it gives an alternative story.
As you can see, Alexa shows that there are increasing numbers of people visiting Facebook daily. This is interesting because it seems to be in opposition to what Google Trends is saying. That said, the 2 results may not be in opposition to one another. Total unique visitors could be decreasing, but usage in some subpopulations could still be increasing.
How Can Facebook Maintain High Valuations?
It seems clear to me that Facebook can’t maintain a high valuation through simply increasing user numbers. There are, however, other ways that Facebook can increase their revenue and hence increase valuations. One way is to add premium features to the site which users might be enticed to pay money for. An example might be voice calling. Considering Microsoft’s recent acquisition of Skype and significant investment in Facebook, this option seems entirely possible. Another option would be in the field of data analytics. Facebook has a huge repository of personal information for hundreds of millions of people worldwide. Surely there are large number of people who would pay good money for this information, however Facebook risks alienating users even further with regards to privacy if they do this. The final and most profitable thing that I think that they could do is to provide display advertising services on sites other than their own. Google currently generates a large amount of their revenue not only from displaying advertising on their own site, but also by paying website owners to display Google ads on their page. They target your ads based on your previous searches, and to do this they track you web browsing activity using their cookies. But Google currently takes a guess at what demoraphic you fall into when displaying advertising. Facebook would have the advantage here, by using their own cookies they could work out exactly what demographic you belong to before the advertisement is displayed.
Note: I thought I would clarify a little about advertising at Facebook. While most people think that Facebook has Google beat in terms of directed advertising, I believe they have a long way to go. For example, Facebook might know my exact age, city of orgin, and gender. But Facebook doesn’t know if I’m a young male from Sydney looking for a new car or a young male from Sydney looking for a new mobile phone. This is an important advanatge Google continues to have over Facebook.