Facebook Could Be Bigger Than You Think

On Wednesday, Facebook borrowed a page from foursquare and Gowalla when it introduced a new location-based service that allows users to share their location with friends. Facebook now has more than 500 million members, many of whom connect via Apple's (Nasdaq: AAPL  ) iPad. So how does Facebook plan to turn that big membership into a bigger business? Why are advertisers so attracted to Facebook? And what would you do if someone offered you $5 billion? Earlier this week, Motley Fool Money Radio Show host Chris Hill talked about the business of Facebook with David Kirkpatrick, author of The Facebook Effect: The Inside Story of the Company That Is Connecting the World.

Chris Hill: Facebook is a private company, so obviously there is a lot we don't know about their finances. Is Facebook profitable?

David Kirkpatrick: It probably is pretty close to profitable right now. It is one of those companies that is growing so fast that profit is a strange concept because while at any point they could pull back the growth lever and turn up the profit lever, their priority is growth, unequivocally. Mark Zuckerberg believes that Facebook is something that should be used and could be used by literally everyone on the planet. So the fact that they have 500 million-plus members now may seem impressive to you and me, and of course it is, but to him, he doesn't really sit back and put his feet up on the desk when he hears that number. He feels it is a population of almost 7 billion people in the world; he wants to keep driving toward a much, much larger number. So that is a goal.

There is going to be a lot of revenue this year, probably close to $1.5 billion, most of it in advertising dollars. But there are other forms of revenue. If [Facebook] were to stop building data centers, if they were to stop hiring new people, if they were to stop building policy offices around the world in order to try to explain themselves to governments and all the countries where they are becoming a social and political and cultural force, they could be profitable today. And I think actually they probably are close to that even still, despite the hundreds of millions of dollars they are investing in data centers and all the many people they are hiring.

Hill: As you said, Facebook recently crossed the 500 million member mark, with revenues somewhere probably in the range of $1 billion to $1.5 billion in 2010. How does Facebook make even bigger money?

Kirkpatrick: I would say No. 1 is to do a better job with advertising. If $1.5 billion is the right figure, and it is definitely close, considering that they have 500 million members, to have $3 a year in per-user revenue is pretty crummy. And in fact, there are plenty, plenty, plenty of social networks and other Web businesses around the world that have a dramatically higher per-user annual revenue rate. I think that is one reason why on the private markets, Facebook stock is currently trading in the vicinity of $27 billion as a market cap. Many, many investors believe that Facebook does have the ability to radically increase its per-user revenue and as a result, its profits.

But advertising can be improved dramatically. It has not been, until fairly recently, that high of a priority inside the company. And as I said earlier, it is still not a huge priority for Mark Zuckerberg. But he has now done something very important, which is bring in a team of extremely accomplished people who are experts at it, and for whom it is a priority, most notably Sheryl Sandberg, who is his clear No. 2 and is the COO at Facebook, and who came from Google (Nasdaq: GOOG  ) . She has now brought with her from Google David Fischer, who is head of advertising, and who was a very, very senior guy at Google in advertising, as Sheryl was when she was there. Those people are two of the world's most knowledgeable and aggressive ad sales and development people.

So they are putting all their efforts on taking the system that Mark developed in order to give that sharing capability to hundreds of millions of more people and layering on top of it monetization engine. Facebook is the most targetable ad medium in history. The reason is that Facebook members articulate data about themselves voluntarily that is enormously valuable to Facebook when it decides to display advertising. So whereas most Internet advertising in some fashion is intended to be targeted, the way most of that targeting happens is by what we would call inferential means. They guess that you are a man and your age and where you live. They kind of know where you live through your ISP probably, but there are a lot of things about you that they are guessing. They are guessing you are a man by whether or not you go to car websites as opposed to cooking websites. And there are a lot of women who like cars and a lot of men who like to cook. So a lot of times those guesses are going to be wrong.

But Facebook doesn't have to guess. On Facebook, you say what your gender is, you say your age, you say whether you are married or not and what kind of relationship you are in, what music you like. Facebook can then show an ad to someone who lives in a certain neighborhood, is of a certain age and is interested in certain things, and you can make it as fine-grained as you want. No other service on the planet really has that ability.

Hill: There have been stories and rumors about Facebook selling to a variety of companies. What are the companies that made really serious offers, and what is the closest Mark Zuckerberg came to selling Facebook?

Kirkpatrick: There is only one time they really came close to being sold, and that is the late summer of 2006, when Yahoo! was offering to buy them and had offered, by the end of the process, probably over a billion dollars. [Yahoo!] made it clear they would be willing to go higher than a billion to buy the service outright in cash, and the reason that Facebook and Mark Zuckerberg were contemplating that was because Facebook had made some half-hearted efforts to break out of the student demographic and open what it called "Work Networks" to allow adults through their workplace to join Facebook. And that had been an abysmal failure.

So there was concern at the company that maybe Facebook would not work for adults. And if that was the case, then its growth perhaps had already topped out because they had already essentially penetrated and blanketed all the high schools and colleges. So the question was, could they grow in the adult market? And if they couldn't, they probably should sell now and they would never get such a high offer again. But before they made that final decision about Yahoo!, they did what they called "open registration" for all adults, and that proved to be extremely successful. The numbers were very high, and at that point they said, OK, we are not going to sell to Yahoo!, and that was over.

But there was one other time that has to be mentioned. In October of 2007, Microsoft's (Nasdaq: MSFT  ) CEO, Steve Ballmer, decided that Microsoft ought to buy Facebook. And even though Yahoo! had only offered a billion dollars a year earlier, Microsoft was so intent on buying it that they were willing to pay $15 billion for Facebook. Ballmer flew down to Palo Alto, took Zuckerberg for a walk around the streets, and made this offer. And Zuckerberg basically just stared him blankly in the face, in effect. He didn't even seriously consider it. Even though he was only 23 years old, and he personally would have probably taken home something like $5 billion as a result of that deal. That is just an extraordinary story, in my opinion, that I think that alone was worth writing my book about, a 23-year-old who turned down $5 billion.

Hill: David just so you know, as soon as you offer me $5 billion, I am saying yes.

Kirkpatrick: Well, I have asked every audience I speak to about the book, I say, "Does anybody here know any 23-year-old that would turn down $5 billion for any reason?" I have never seen a hand.

Apple has had a big influence on Facebook. Read more on Apple and Facebook's budding romance here.

Neither Chris nor Mac owns any of the stocks discussed. Apple is a Motley Fool Stock Advisor selection. Google is a Motley Fool Rule Breakers selection. Microsoft is a Motley Fool Inside Value pick. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Google. The Fool has a disclosure policy.


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  • Report this Comment On August 22, 2010, at 1:01 AM, alexkhan2000 wrote:

    It doesn't surprise me that Zuckerberg turned down Ballmer's offer. Guys like him, Jobs, and Gates aren't about the money. It's about the fight, about growing the business, about making a mark for the ages. Alexander the Great was the epitome of that mindset. He conquered 90% of the known world in his time and was probably the wealthiest and the most powerful man who ever lived by the time he was 25. But he kept going and going to conquer more, putting his own life at risk time and time again fighting at the front. It's guys like him (and Zuckerberg, Jobs, Gates, etc.) who make the world go round. Cool story.

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