What investors need to know about Facebook’s slowing growth

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:

Number of searches for 'Facebook' on Google.

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:

Daily worldwide unique visitors to Facebook.com

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:

Daily US unique visitors to Facebook.com

Daily Germany unique visitors to Facebook.com

Daily UK unique visitors to Facebook.com

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.

Daily unique visitors according to Alexa.

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.

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19 comments

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  3. SeaKY · June 13, 2011

    MySpace crashed when high schoolers grew tired of it. Facebook blossomed in popularity as this demographic moved to college. Then the parents came on board to try this “cool” site out, share photos, and reconnect with their high school buddies. Now kids are getting out of college, will grow tired of the embarrassing tagged photos and perhaps move on. Parents and Boomers are already tired of reconnecting…just ask them. These are my predictions as a Gen Y’r. We are easily entertained, but just as easily bored and as a result will either move on or grow up…either way FB will become less relevant if this trend persists.

    • jjansson · June 14, 2011

      Totally agree with you here. The internet goes through fads. The fads don’t stick unless they are adopted by business (think of email). Because facebook never opened itself up to be an open platform (for example allowing businesses to have their own facebook server) and because facebook kept changing it’s dodgy terms of service, Facebook was never adopted beyond shameless self promotion. Business never have and never will use it as a communication tool.

      • Scott · June 14, 2011

        Excellent point. You can see how closed-off Facebook makes ecosystems – for proof just check out TechCrunch. They love forcing visitors to use FB to comment because it dashes away all anonymity among commenters (and makes discussion more friendly because people are afraid to speak their true feelings with their real identity next to it). Nevermind all the traffic and user participation they lost because of that move. And let’s not even worry about what’ll happen to sites built on the popularity of FB (and Twitter even) if a site’s appeal starts to fade.

        And yes – I genuinely think people are tired of Facebook. The only reason I can see it existing longer than Myspace is that there is no other decent alternative out there. Microsoft and Google had the best chance of creating a “next gen” social network but instead they haven’t done anything significant.

        With rumors of FB wanting a $100 billion IPO, I seriously hope the true data from this site starts to come forward. I cannot believe (at least domestically – where the real money and interest is) that this site is growing by leaps and bounds anymore.

      • SeaKY · June 14, 2011

        This is very true, although I have witnessed top management using two accounts on Facebook, for personal and business interaction. Some business communication may occur over Facebook, but it won’t be substantial until companies have the ability to monitor employees, similarly to what skype has done.

      • nik · June 17, 2011

        ^ That’s one of the built-in problems with Facebooks naive representation approach. Maybe I don’t want my 5 closest friends to have all the exact same information about me than work colleagues whom I perhaps never met face to face.

        Facebooks idea works well for college students connecting with other college students – perfect. But it falls short when it comes to people and their social graph in a wider context.

        It’s a moot point though – facebook will die because people are getting bored of it. It’s already happening.

      • nik · June 17, 2011

        By the way I was looking for a nanny and one contacted me and ended up friending me on facebook. Ok, fine, I didn’t know her but I did it anyway. Talk about a treasure trove of information on your future employee… not sure she really wanted me to see all those “here I am totally smashed at a party with some random dude” photos…

  4. KamakshiSri · June 14, 2011

    The fall in the user numbers is, basically, for its trick of trifling with user privacy and selling user data. Here is an url referreing that:
    http://techcrunch.com/2011/05/13/facebook-faces-lawsuit-over-unauthorized-sharing-of-user-data-with-advertisers/.
    The second reason is its ownership, this I am saying from an investor point of view. A company can’t grow when it’s ownership is in question.
    Another point is the dirty trick it tried playing on Google. Here is the URL : http://techcrunch.com/2011/05/12/facebook-loses-much-face-in-secret-smear-on-google/

    FB is a hanging place for jobless guys, or guys who have nothing to do but professionals never liked to connect over it. This change signifies people have got into something worthwhile. It’s a good signal.

  5. Jefry cruz · June 15, 2011

    I really agree with your statements, FB is a trend just like MS was. It will fade, FB is loosing what made it cool in the first place, Its cleanses and the fact that it was the “cool spot to connect with friends” Now FB motto is to get people into being more open, and that is going against what made it so suspenseful.

  6. nik · June 17, 2011

    I think facebook valuations *could* be correct but only if the company comes out with some amazing new ways of making money.

    Google used to be a great search engine but people were wondering how it could be worth so much. Then they hit one out of the ballpark with their incredible business model – targeted advertising – and that’s what really made the company into the giant it is today.

    facebook had an opportunity to take over the entire internet. Friends of mine suddenly used facebook that previously had not been active on the internet. These friends also dumped their hotmail or yahoo mail for facebook mail. But I think that chance has slipped away now. They need a major new idea or they’re going the MySpace way…

  7. Bipin Gaur · June 22, 2011

    What is really surprising after reading all the above comments is that no one mentioned linkedin. I am on both linkedin and facebook, and I find linkedin much better, be it interface, search or information. Facebook is just fluff and self propaganda. You may have time for it when you do not have something better to do. I am paying $50 per month to linkedin and fairly happy for it. I would not want to pay even $10 for all of facebook offerings. That to me may be the whole reason facebook is not going to grow further, There is really not much value for paying customer there.

    • jjansson · June 22, 2011

      I disagree. The basic premium packages is $25 a month, which basically gives the ability to do what facebook does. For free. If as many people joined linked in as joined facebook, you would have $210 billion worth of annual revenue. Making it a $4 trillion dollar company. Pretty cool, better go buy some stock. That is unless you think the majority of people won’t pay this massive amount per year. I wasn’t aware that this is how much people paid for linked in. Maybe you get your money’s worth out of it, but I don’t think I would. And I use facebook far too much for someone who dislikes it so.

  8. Richard James · June 27, 2011

    Totally agree that Facebook is BORING.

    When it was just me and a few of my friends it was amazing. Now it is like an echo chamber and there are so many random connections I don’t post anything to it. I go on about once per week to check my messages and that is about it.

    I don’t think the future of social networking is a monolithic, do it all site. It will take the form of an ID you carry with you (on your phone I guess) which you use to interact across the web. This is pretty much already happening with different services from Facebook, Twitter & Google.

    But I think Twitter is far better situated to take advantage of where things are going. It will evolve with add-ons (like the new Pic thing they have) but at it’s core it will remain lightweight and portable and eventually be the key that most people use to interact on thew web.

    And in the mean-time Facebook will get bogged down in itself and drown in the quagmire that is itself.

    • jjansson · June 28, 2011

      It’s an interesting point that you made, about Facebook being a do it all site and getting bogged down in itself. I’m guessing you are alluding to feature creep here. And Facebook certainly has a terrible case of the creeps.

  9. Justin Dawkins · June 28, 2011

    James,

    First of all great post. Secondly I wonder what your thoughts are around emerging markets and international accessibility. The data here represents a broad view but we all know that Facebook has yet to capture China (1.3+ Billion people just matter), many parts of Africa have very limited access to concrete roads, let alone the internet & Facebook while other countries continue to flip the switch on access to the internet limiting usage & adoption in those areas. I realize that these are just a few countries/markets but my questions to you is; with Facebook being such a large internet property and usage and accessibility being directly related to political turmoil, economic disparity around the World and other accessibility challenges, shouldn’t we look at usage and adoption compared to these things as well as the standard data points we analyze. I do agree with some of the other comments here, and yes adoption is slowing, but I believe it could be because the product and its users are maturing. A mature user base doesn’t just mean that people are bored, rather users have (possibly) just refined their usage to more of a necessity making it more of a personal utility (think address book). This maturity could actually be good for Facebook as it forces them to innovate to grow usage, not just sit back and rely on adoption. I still haven’t drawn any personal conclusions but thought I ‘d offer a few more ideas.

    Let me know your thoughts.

    Regards,
    -Justin

    • jjansson · June 28, 2011

      With regards to China, I don’t think facebook will ever be that big. China already has massive social network saturation there, so there’s not much market to capture. That ship sailed for Facebook long ago.

      In terms of other areas, Brazil and India is increasing for Facebook, but part of the debate that has really been ignored is that Google’s Orkut actually has a reasonable hold in both those markets, despite what everyone is saying about Google’s “failure” in social. What you may be seeing in Brazil people joining both Orkut and Facebook to keep up with friend both at home and abroad, like what many of the Chinese students do here in Australia. This to me says there will be growing demand for cross site interoperability. We’ll see if this happens, probably not since Facebook’s profitability model requires user lock-in.

      When it comes to Africa, it’s cool to have that user base and to provide the tools that have allowed many of the revolutions in North Africa to occur. But my belief is that currently the advertising dollars produced by those countries are small to negligible. If you want to make big money in Africa, it won’t be in social networks. It will be in building telecommunication infrastructure, health care, agriculture, mining and education. Africa has laid dormant due to dictators and HIV. As we a coming closer to defeating both of these, Africa will bloom in the same way that Asia has over the last 20 years.

      To sum up and answer your direct question, I do believe that Facebook’s value can be measured in social outcomes. In fact that is one of the reasons people use it (including me!): to communicate their social message which is sometimes political. But when it comes to an IPO, those trading houses don’t care how many dictators were toppled due to Facebook. They care how much money they are generating, and hence the metric for determining if Facebook is worth $100 billion is advertising revenue which is directly related to user numbers and time on site.

  10. Sunday Dalee · June 29, 2011

    This is a great article. Many thanks for spending some time to explain all this out for all of us. It’s a great help!

  11. Buckhead Dan · October 3, 2011

    totally agree! I hate how their TOS/Privacy change constantly and I have to get on there & change all my settings. I’ve found them to be reset or nullified after they do an update which is also annoying.

    I have friends of friends of friends whom I dont know or even talk to. Yes I could ‘de-friend’ them & go and redo all my privacy settings but honestly…that’s just more work! Myspace had a surge w/musicians lately because FB can’t deliver the same things. Both can be good for a business, but again…so much work. I’ve never been a fan of FB for the record. I dont post much at all. Tagged photos are stupid, especially when people put up stuff that you don’t like. Just glad I kept it so I could use Spotify. FB will be a dinosaur soon, it’s half way there.

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