Can Facebook justify its valuation?

This article was originally published on May 13th 2012 in Japanese as part of my weekly column for Sankei Business-i.


Facebook will IPO at a valuation of nearly 100B USD. That’s a lot of money. Facebook is IPO’ing at 25 times revenue. High even for companies that have been public for some time with stable business models. Most companies IPO at four times their revenue. Clearly the company is not worth 100B today. The value is based on the belief of what they will be worth in the near future.

To put things in perspective, Facebook believes that it is 1/5 the value of Apple. More than 1/3 the value of Microsoft and 1/2 the value of Google.
The company makes a lot of money from advertising but they also have a very serious problem with their advertising platform. It doesn’t really work that well.

One issue is that there aren’t a lot of advertisers. Users are growing at a faster pace than advertisers joining the platform. This means that users are seeing the same advertisements more often. When you see an ad too many times you begin to subconsciously ignore it.

Another problem facing facebook is users are increasingly visiting the website from mobile devices. But the company hasn’t figured out how to monetize users with advertisements on mobile yet. Mobile advertising globally hasn’t really taken off. There are a lot of reasons for this, but mobile ads perform best when the user is taken to a mobile site optimized for monetizing mobile users. While mobile sites exist throughout Asia very few companies have them in the west.

While online marketers are beginning to whisper that banner advertising on Facebook is a waste of money that could change very soon.

Facebook’s most valuable asset is its data. Investors are valuing facebook based on its future ability to monetize the huge amount of data it has on users, a competitive advantage over all other advertising platforms, including Google.

For example my friend recently became really interested in photography. Nearly every week for the last two months he has posted something about his hobby. Equipment he has purchased, photo sessions he has setup at his house. Yet he isn’t seeing advertisements on facebook for anything related to photography. This is a major failure of the facebook advertising platform.

Facebook advertisers currently can only target users based on what they have added to their profile. Age, marital status, location, pages they have liked. But you can’t target people based on their activity. You can’t say “show this advertisement to people who mentioned ramen in their status update.”

Increasingly advertising is moving away from demographic targeting to real time action targeting. Advertisers are getting smarter about taking advantage of the real time web. Instead of advertising to women in Tokyo, they want to advertise to anyone who has talked about womens clothing in their facebook status update or on twitter within the last 30 minutes. Advertisers want to be able to show a travel advertisement to someone who casually mentioned that they “need a vacation.”
You can’t do that on Facebook now. But if facebook successfully executes on building out the advertising platform, eventually you will, and when that happens the Facebook will immediately become more valuable.

In the meantime there are companies like SocialFlow <> which allows brands to target users in real time based on conversation matching. If you have content or a coupon related to Hawaii and there is a sudden increase in discussions related to Hawaii, that content will go out automatically to channels like Facebook and Twitter.

Then there is Klout which can graph the activity of users but looking at their discussions and rank their interest and expertise within categories. So an advertiser could potentially target only people who have shown an interest in travel, not based on what they have defined in their profile, but based on the conversations they have had in the past and content they have shared with friends.

Technology like this will power the future of real time marketing and advertising. But the leading companies perfecting this aren’t the social networking platforms themselves.

Investors are betting that Facebook will eventually build in the ability to monetize every action a facebook user takes, but we have no idea how good they will be at it. Facebook has to build a platform that will keep one billion people happy. They are not a advertising company. It’s not clear how much effort they will place in advertising in the future.

Now that Facebook has launched a mobile application platform. Similar to iTunes iPhone app store. One has to wonder about their commitment to monetizing their most valuable asset, the user data they have now.

There are two monumental tasks facebook has to manage to continue building value. First they have to figure out how to monetize user data if not in real time than based on historical data. Second they have to keep users interested in facebook because if users aren’t using facebook, you can’t very well advertise to them.

Luckily Facebook is so large that even if they improve their advertising targeting ability by 20% it’s likely to have a large impact on revenue. Unless of course people stop using facebook.

Its a risk buying stock in a company so young with such a high valuation. But people were complaining about Facebook valuation when it was valued at $99B less. They have done a good job proving they can monetize users so far. It would be hard to bet against them, even at 100B.