So…It’s Not a Smartphone: Thoughts on Facebook’s New Graph Search

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

Rumors have swirled since Facebook (NASDAQ: FB) announced an event to reveal “something it was building” that took place earlier this week. We at Valuentum have heard everything: Facebook is buying RIM, the company is building its own smartphone, or maybe Zuckerberg was ready for his Steve Jobs moment, where he’d show the world something we didn’t even know could exist. At the end of the day, it was an evolution of the existing timeline feature and a direct attack at Google (NASDAQ: GOOG), Yelp (NYSE: YELP), and even Twitter. This innovation is the Graph Search.

When Valuentum profiled Facebook after its IPO, we suggested that one of the company’s greatest paths to profitability was search, and we continue to believe it is. Graph Search, still in beta testing and not fully rolled out, allows users to search everything their friends have shared. CEO Mark Zuckerberg explains it in this video, and we think the function will work to help keep users engaged and more importantly, keep them within the walls of Facebook. We think it was only a matter of time before search evolved on the social network, and we think the potential for monetization is significant. Although plans to monetize the idea have yet to be announced, we think the company will be able to seamlessly integrate advertisements--much in the same way it has sponsored stories.

The biggest loser in this event is probably Google, but Facebook’s move is hardly something that will change our long-term thesis on the search giant (we still like the firm). Graph Search seems like it will do an excellent job of filing the holes that Google can’t fill (and wanted to fill via Google+). With word of mouth being among the most effective forms of advertising, we believe companies could flock to Facebook’s search where it could pay for “word of mouth” or to gain priority in a search. Even if it takes some time to aggregate enough content to make searches useful, “Zuckerberg’s Law” dictates content sharing may double every year, so the total amount of information available in just a few years could be astonishing.

Facebook could also cannibalize some of Yelp’s business by replacing reviews. Although the social network already has a limited ratings system, it could easily expand its breadth and depth without altering its existing infrastructure much. Yet, since Yelp has accumulated such a wealth of reviews, we think it could survive some competition from Facebook. Regardless, the move is a clear attack on Yelp’s business model.

Graph Search is also an attack on Twitter since it will allow users to search for specific terms that have been posted. But for now, the search is limited to friends (and friends of friends), so we do not think it is an immediate threat. Twitter and Facebook can peacefully coexist, in our view.

Overall, the move is a step in the right direction for Facebook. It could mark the first of what we think will be several moves towards building the firm’s search capabilities into a potentially transformative product. After years of running the company without regard for earnings expansion, we think Zuckerberg is focused on making the firm an internet powerhouse in all respects. If Facebook’s next quarter shows continued improvement in mobile advertising, we would consider raising our fair value estimate.

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