Only $50B? Facebook Stock Is Still a Steal

Everyone from The New York Times to Fortune to CNN has been weighing in to decry the excessive hype leading to Facebook’s reported $50 billion valuation, as if there’s some immutable law of nature that private Internet stocks can’t be worth that much.

I don’t have any inside information about Facebook’s finances, and I’m not a Goldman client. But I’m convinced that when we look back at this investment, it will rank as one of the best stock opportunities available today — akin to buying Apple stock just before the release of the iPod.

Yes, there are many examples of unjustified Internet hype in the market today, but Facebook isn’t over-hyped; it’s simply an exception to the rule, a once-in-a-decade occurrence of a company that fundamentally changes the way we live and work, and has built a profitable business with huge growth prospects in the process. Let me explain why I’m so sure of this.

Advertising isn’t a business model? Tell that to Ogilvy

Detractors point to Facebook’s business model — advertising — as evidence that the company can’t possibly be a big business. Isn’t advertising a $210 billion business in the U.S., and about three times as big globally? So the objection could be that Internet advertising isn’t “real.” But hold on: internet advertising is expected to be a $25 billion business and grow 70 percent by 2015. And while SNL Kagan doesn’t yet break out social advertising as a category (I bet they do soon), Facebook reportedly did close to $2 billion in revenue last year; pretty good for no business model.

Sure, there is something behind our general fatigue toward websites with online advertising-based business models. There are innumerable small, sub-scale sites that can’t get the attention of premium, brand advertisers that drive the bulk of this spending, due to the small, fragmented size of their audience. But let’s not throw Facebook under the bus based on this. This is a site that reaches 500 million, sorry, no, 600 million people–- half of whom log in every day -– with a wealth of data that allows targeting on a level never before seen. Want to run a campaign that reaches fans of Natalie Portman? Facebook just happens to know 61,860 of those in the US. What about Lady Gaga fans who speak French? 23,060. Men who like Aardvarks? 2,260. You get the idea.

Detractors point to the current state of Facebook’s sales team and ad units as evidence that it won’t be a big business. I sometimes hear people say “well, I’ve never clicked on an ad, so…” usually trailing off afterwards. Think of it a different way: Facebook built a business with $2 billion in advertising revenue, and you’ve never clicked on an ad? Imagine how big it will be when you do start clicking…regularly. The television industry has had 60 years to evolve its ad formats and sales forces; Facebook’s only been at it with any seriousness for the past three or four years. Give them another two or three to get it perfected.

Facebook has sound fundamentals — no, seriously

Let’s assume that the data reported in The Wall Street Journal is accurate, and that Facebook ended 2010 with close to $2 billion in revenue, implying $500 to $600 million in profit using the range of reported profit margins. That’s a revenue growth rate of 157 percent and a profit growth rate of 150-200 percent from the $200 million in profit reported for 2009. If true, it would actually be conservative to expect their profit to double in 2011, implying a forward P/E of 42-50 for the Goldman investment, which puts it right in line with those of Amazon (53), Baidu (45), and Netflix (49). What’s so unreasonable about a forward P/E of 50 for a company like Facebook with an audience size and engagement level that implies many more years of doubling revenues and profits ahead?

The problem is that now that financial data is trickling out, we’re comparing Facebook to public stocks of similar size, and public market investors just aren’t used to companies that have more than doubled their revenue and profit in the past year and can credibly forecast to continue to do so – for at least a few more years. Comparisons to Google’s current financial ratios are spurious, for Google’s several years of post-IPO meteoric growth are well behind it. The company has grown less than 10 percent a quarter for the past 5 quarters.

Facebook is no one-trick pony

The vast majority of Facebook’s revenue today comes from one form of advertising or another. Remember last year’s brouhaha over Facebook Credits and Facebook taking a 30 percent cut of developers’ revenue? Given the size of companies like Zynga (once estimated to generate $50 million in revenue per month), won’t that be an even bigger number over time? Considering that Credits weren’t rolled out until the end of 2010, I’d think of this entire business as “new” over the current revenue base. And given the company’s breadth and usage, who’s to say that Facebook couldn’t make a run at other, already proven business models like Web search and local advertising?

Think Apple Stock is too expensive? Buy shares in another visionary

Call me old-fashioned, but here’s something else Goldman clients are buying with their Facebook shares: a team led by a visionary, not unlike Steve Jobs, who’s highly skilled at predicting our future modes of personal communication and interaction. In Mark Zuckerberg, Facebook’s stockholders are getting someone who has the foresight to shape the future patterns of how we spend our time and keep in touch. And he’s demonstrated an ability to execute on these prophecies in spite of protests by the vocal masses. Remember the uproar when Facebook released its news feed back in 2006? The company apologized at the time for a lack of communication but completely ignored the general consensus and kept the news feed intact. Anyone want to eliminate it today? It’s now the focal point of the site and the basis for zillions of hours of activities and eyeballs. Remember predictions that no one would spend their time using applications on the Facebook platform? Tell that to the 18 million people that played CityVille today, and the 2.5 million developers building on the platform. And these are just a few of the many product innovations like photo tagging that Facebook has made commonplace.

What could possibly go wrong?

Well, plenty of things. We all remember AOL and Myspace. This kind of skepticism has plagued Facebook at every turn –- only to be dismissed as the site achieves the next milestone and continues its exponential growth without missing a beat. I’m sure eventually there will be another technology juggernaut that emerges to steal back our time and scare Facebook about being disrupted. But this has never happened overnight, and no one is pointing to a company or idea currently out there that presages Facebook’s irrelevance.

I look forward to Facebook going public so that we finally have access to its financial data. Only then can we advance this debate as to whether we’re truly looking at a “once-in-a-decade” kind of company. In the meantime, I’m sure we’ll see a lot more backlash against the “hype.” I won’t have time to read it though; like a lot of you, I’ll be too busy perusing photos of Bali beach vacations taken by junior high-school classmates to whom I haven’t spoken in years. And maybe I’ll even click on an ad or two in the process.

Ethan Kurzweil is a Vice President with Bessemer Venture Partners in Menlo Park, California. He works with Internet companies of all types, including Playdom, Zoosk, Crowdflower, Twilio, Reputation Defender and OpenCandy. You can find him on twitter at @ethankurz. The views expressed in this post are his own, and do not represent those of Bessemer. Disclosure: Ethan has a very small position in a Facebook secondary vehicle, purchased in 2010.

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