Why I'm Buying More Facebook and Why You Should Too!

Khari is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There was a time when one would use a phone book to find the contact information of a local friend or family member. Times have changed and with the advent of Facebook (NASDAQ: FB), it is now possible for people to reconnect with their friends and family regardless of where they may reside in the world. With a user base of over 1 billion people, Facebook will remain ingrained within our daily lives for the years to come. This continuous use of Facebook by the masses has the potential to translate to many high revenue generating opportunities for Facebook.

Historically Facebook has made money in two ways. Through what we call the payments business and by selling ads. While the payments business accounts for roughly 18% of Facebook's revenue, the other 82% comes from ads purchased through Facebook. More recently Facebook has added a Gifting service which allows users to send gifts to their Facebook friends for a small fee.

Many have sought to value Facebook by its present day payments and ads revenue. I would caution against this. I feel that there are many possible streams of revenues that investors remain unaware of. The primary asset that Facebook has is its user base.

If we make the assumption that Facebook is currently priced to reflect its true value, then my thoughts are that given the potential of Facebook, the stock is in fact significantly undervalued. As new products or services are discovered, even adoption by a small portion of Facebook's user base would mean large profits.

More than a social network, Facebook is a social utility that is here to stay. The opportunities here are great. The sentiment among most investors is that if Facebook can profit from mobile advertisements then the stock has a positive future. While this is true, mobile is just a small part of Facebook's potential. When you place some our country's smartest Engineers with a knowledgeable and passionate management team, then add to that the capital resources, I believe that good things are bound to happen. An investor that understands this concept and understands that this is the basic premise that led to the success of companies such as Google (NASDAQ: GOOG) and Apple (NASDAQ: AAPL), stand to make a nice return on investment here in Facebook.

By using Porters Five Forces analysis to assess Facebook, we will see that Facebook is positioned to do well in the years to come.

Supplier Power - Facebook is unique in that its platform facilitates the interaction between parties within its community of over 1 billion people. Facebook depends on their 3rd party web app developers to provide quality web app's for their community. If a web app developer were to submit a web app, this developer would hold little bargaining power because Facebook has the option of rejecting this developer's app from being used within the community. Facebook could also find another developer who would be willing to create a similar app, at terms which would be more favorable for Facebook. This is a sign that Facebook's suppliers, as individual entities, hold minimal power. This is great for Facebook and its shareholders, because the less power that the suppliers hold, the more flexibility Facebook has with respect to negotiating deals that have the potential to increase Facebook's profit margin.

Buyer Power - If we assume that the buyers at Facebook are individuals or companies who purchase Facebook ads then, we can see that the buyers hold minimal power. Facebook controls the price that it charges users to post ads on its site. This price is dictated by an algorithm that Facebook uses which is based off of the demographics of the target audience. In other words if a user wishes to purchase ad space, they will need to select their target audience and then post their ad.

As FT.com reported, "[The] demand for Facebook advertising is increasing faster than the supply of ad space on the site…" Since there is a limited supply of ad space and an increased demand for this space, the laws of supply and demand dictate that Facebook will continue to see an increase in revenue for its ad space. In addition to seeing an increase in revenue, Facebook will also hold the majority of the power since the buyer has little room to negotiate price when Facebook has a high demand and limited supply for its ad space. Minimal buyer power allows Facebook to maintain ad costs that are favorable for Facebook and its shareholders. These favorable ad costs ultimately lead to higher revenue and return on investment for Facebook shareholders.

Competitive Rivalry - Facebook has the potential to compete with many companies depending on what product or service it offers to its user base. For instance, the Facebook Gifts service would compete with a company such as Amazon (NASDAQ: AMZN). The competition would be based on products that an individual would purchase for another individual. In this specific example, Facebook has the advantage in that it has a pre-existing community of users for which it already has many of their physical addresses on file. The benefit that comes from Facebook having the address of the members of its community is that a user could purchase an item as a gift for another user without needing to contact them for their address. This serves as a distinct competitive advantage over Amazon, in that a Facebook user could send a surprise or last minute gift to another user. While an Amazon user could send a gift to their wish list, they would be unable to send to a member of Facebook's large community, unless if they sent it through Facebook. 

Conversely, as mentioned in a recent article by Tim Peterson, “Amazon has built a proprietary real-time bidding platform that … lets the company re-target its users across the Web based on their browsing and purchase habits on Amazon’s owned-and-operated properties.” In effect, this new RTB platform would allow Amazon ad space buyers to target their ads in a similar way that ad space buyers within the Facebook Ad Manager, currently target their ads. Amazon expects that this new RTB platform will be fully functional and “self-serve” to its buyers, sometime in the first quarter of 2013. For the time being it appears that Facebook has the competitive advantage against Amazon in both the Gift service as well as the selling of ad space. However, it is important that we as investors continue to remain aware of the new product offerings of Facebook and Amazon, and how these new offerings will affect both of these companies.

Facebook could also compete with a company such as Google when it comes to search. The Forbes website has quoted Facebook CEO, Mark Zuckerberg, as saying,

[Facebook is uniquely positioned to compete in the search market]...and when you think about it from that perspective, Facebook is pretty uniquely positioned to answer a lot of the questions that people have. So what sushi restaurants have my friends gone to in New York in the past six months and liked? . . . . These are queries that you could potentially do at Facebook if we build out this system that you just couldn't do anywhere else.

So we can see that the rich user data that Facebook has collected on its users activities on the site, will give Facebook a distinct competitive advantage over a search engine such as Google. In addition, Facebook competes with Google in social networking. In 2011 Google created a social network which it named Google+ (Google Plus). As of December 2012, Google+ has 500 million registered users, while Facebook has over 1 billion registered users. Casey Newton writes in his article that, “Facebook's billion monthly active users make it 10 times the size of Google+, even if Google did hit the 100 million active-user mark in roughly a quarter of the time that Facebook did.” This statement by Newton reminds us that the number of active users as opposed to registered users, is what is important for a social networking site. The larger the amount of users that are active, the more information and revenue a company can obtain from each user. At this point it appears that Facebook has the clear competitive advantage over Google in both its search and its social network offerings.

A final competitor that Facebook could compete with is Apple. Facebook recently launched the Facebook App Center. While Facebook CEO, Mark Zuckerberg, indicated that Facebook does not intend to compete with Apple’s App Store, it is believed by many that Facebook is currently working on a Facebook phone that would enable Facebook to provide its own apps to users, through the use of its own operating system. If this were to happen Facebook would hold a competitive advantage over Apple when it comes to the sale of its apps. This is due to the fact that Facebook keeps track of its extensive user data. In addition, if a Facebook phone were to be released, it is likely that this device would cut into the market share of the widely popular Apple iPhone.

Here we see that not only is Facebook able to compete in its core industries but it is also able to compete in and disrupt other industries. This is a positive sign for Facebook investors because it shows that Facebook management is willing and able to compete with some of the biggest competitors within various industries.

Threat of Substitution - There are many companies that can substitute one of Facebook's revenue streams, however Facebook can develop multitudes of revenue streams around its growing user base. The versatility that comes with having multiple products or services that can be offered to a user base, is a positive factor for Facebook investors because it diversifies the offerings of Facebook. With this diversity comes less risk that the loss of a single stream of revenue would affect the profit of Facebook.

Threat of New Entry - At this point the threat of a new competitor coming and adopting Facebook's business model is highly unlikely. The amount of time, money and effort that it would take a company to develop a 1 billion person user base would discourage many, if not all, potential new entrants. A decreased threat of new entry correlates to an increase in the longevity of Facebook, which is a positive thing for Facebook investors.

Some may question what will happen if Facebook begins to lose its user base. It would most certainly begin to lose revenue. However I believe the chances of this happening is highly unlikely. One may point to the demise of MySpace. However, the concept of Facebook being more of a social utility than a social network means that people actually have a useful purpose for Facebook. Whether it is a parent communicating with a child who is off to college, or a busy professional keeping in touch with his old college friends, many believe that the connections that we make on Facebook are too valuable to lose.

In closing I would recommend that any investor that believes that the market has not factored in the numerous products and services that could be offered to Facebook's user base, should be aggressively buying the stock at this time. I have intentionally provided a qualitative analysis rather than a quantitative analysis because in this case the "numbers" do not tell the whole story and have the potential to mislead an investor looking to make an attractive ROI from this stock. The thought is that if the market has not factored in Facebook's future revenue streams, then this stock is undervalued and is destined to rise as these products and/or services are introduced to the Facebook community. I recommend that a speculative investor should continue to purchase this stock until the market begins to factor in the fact that Facebook is a social utility that will market numerous products and services to its growing user base for the decades to come.

 


khariparker owns shares of Apple and Facebook. The Motley Fool owns shares of Apple, Amazon.com, Facebook, and Google and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Apple, Amazon.com, Facebook, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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