I was about 2 hours into a 5 hour drive en route to an annual weekend golf trip when Facebook went public. That made me a captive audience for the 70 something year old family friend (who admittedly is a sharp cookie at his age and a damn good golfer) in my back seat as he lectured the rest of us on why the stock would be worthless in five years. In the weeks since I’ve heard a million flavors of the same message from people who’s tech savvy ranges from expert hackers to completely clueless. I respectfully disagree, and I think that there is a compelling technical argument that can be made for why Facebook has tremendous upside as a company. So let’s consider the question: should we all be buying Facebook stock at post IPO prices?
The Completely Tangential Bit
The first answer that I get from most folks is no, because Facebook adds no real value to people’s lives. In fact in some ways the result of the company’s existence is a net negative because it causes people to waste massive amounts of time and/or productivity. The company doesn’t produce goods or real services, and some would argue that it’s just a glorified LOLcats. I actually kind of agree, but I don’t think that it matters. What Facebook does produce as a sort of byproduct is an absolutely massive repository of personal data. More on that later.
The Red Herring
The next objection that people raise is based on an assumption that the primary way to monetize the website is ads. The company has certainly toyed with all kinds of ways of putting paid content in front of users, and the early returns seem to indicate that Facebook’s ads don’t work (at least not compared to Google’s paid search advertising). It doesn’t take a rocket scientist to realize that social pages are a whole different beast than search results pages. When people visit Google their intent is to navigate to another page about a topic. They don’t particularly care whether the link that takes them there is an algorithmic search result or a paid ad, they’re just looking for the most promising place to click. When people visit their BFF’s Facebook page they aren’t looking to leave the site, they’re planning on killing some time by checking what their friends are up to. So again on this point I agree; I’m skeptical that Facebook will never see the kind of crazy revenue growth from ads or any sort of paid content on their side that would justify even the current stock price. But advertising is just one way to skin a cat…
The Glimmer of Hope
But slightly off the topic of ads, and in the related space of online sales and marketing is where the first signs of promise can be found. Let’s get back to that data thing: Facebook has an absolute gold mine of knowledge that other companies would pay cold hard cash to access. Consider Amazon, for example. Amazon spends plenty of money mining user data to make more educated recommendations based on past purchase history. What would it be worth to them if they could find out that I have an 8 month old daughter, so I need to buy diapers on a regular basis? That I love Muse, so I may be interested in purchasing and downloading their new album? That I checked in at Century Link Field for a Sounders match last week, so maybe they can tempt me with a new jersey? Those are some of the more obvious suggestions, but there are actually more elaborate scenarios that could be interesting. What if you could combine Amazon purchase data with Facebook social graphs and figure out that three of my friends recently bought a book on a topic that I’m also interested in, and then offer those friends and I all a discount on a future purchase if I buy the book as well?
Facebook’s current market cap as I’m writing this is sitting at 57 billion. To get to a more reasonable 20 price to earnings multiple that seems relatively inline with other growth companies in the industry they need to add around 2 billion in annual earnings. Based on the numbers that I could dig up, that’s less than 1% of online sales in the US alone. Is that possible? Consider the margins of the biggest online retailer. Amazon is legendary for operating on razor thin margins, but their US margins last year were around 3.5%. How much of that margin would they part with for ultra meaningful personalization data that could have a huge positive impact on sales volume? Also, keep in mind that these numbers are for the US only, and they don’t include the astronomical projected growth in online sales moving forward. Regardless of exactly what the model looks like, I think there is a path for Facebook to leverage their data to grab some small piece of that growing pie.
The privacy hawks out there are already sounding alarms, I can hear them from where I’m sitting. But who says that there isn’t a model of sharing data that Facebook users would be happy with? I would venture that there are arrangements where users would be happy to share certain kinds of information to get a more relevant shopping experience. Taking things one step further, there are certainly users who would expose personal information in exchange for deals or rebates that online retailers like Amazon could kick back as an incentive to get the ball rolling, and Amazon isn’t one to pass on a loss leader that drives business with a long term promise of return on investment.
The Real Diamond In The Rough
And that gets us to the crux of the matter. Online sales are just one example of a market that Facebook can get into and leverage it’s data to make a buck. The evolution of computer hardware, the maturity of software that makes it trivial to perform distributed computation in the cloud, and continued advances in machine learning have ushered in the age of big data. Computer scientists who specialize in machine learning and data mining are being recruited to solve problems in every field from pharmaceuticals to agriculture. And the currency that these scientists deal in is huge amounts of data. Facebook has data in spades, and it has a very valuable kind of data that nobody else has.
The model for monetizing that data isn’t clear yet, but I can think of possibilities that make me optimistic that good models exist. For example think about the kind of money that Microsoft continues to pour into improving Bing and leapfrogging Google’s relevance to become the leader in online search. Facebook’s data could be an absolutely massive advantage in trying to disambiguate results and tailor content to a particular user. Google’s SPYW bet and Bing’s Facebook integration are different approaches on trying to integrate bits of social data into search, but they fall way short of the kind of gain that could be had via direct access to Facebook’s massive amount of social data.
Or suppose that a company or government body is trying to gain information about the spread of a particular disease. Maybe they have medical records that include the identities of people who are carriers, but not much more than that. If they had access to Facebook’s data they could suddenly know about the ethnicity, social network (who’s hanging out with who), and habits (through check-ins) of people in both classes: carriers and non-carriers. Applying machine learning to that training set may yield some interesting information on what traits correlate with becoming a carrier of the disease.
The One Armed Bandit
Of course, there’s a risk involved. As a friend of mine aptly pointed out, my case for Facebook’s value looks something like: 1) have a lot of important data, 2) mystery step, 3) profit. I would argue that if the mystery step was clear today, the valuation of Facebook stock would be much higher than even where it’s currently trading. I’ve given a few fictional examples to make the case that the mystery step probably exists. If you buy that argument, then you too should be buying Facebook stock. And this bar may be serving some expensive drinks in the future.