Why Facebook Is Still Cheap

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Value hounds will tell you Facebook's crazy valuation is proof positive of a social media bubble that's doomed to pop. They're wrong. Actually, that doesn't quite capture it. They're not just wrong, they're spectacularly wrong.

Facebook is cheap because it's the most important online display-advertising platform. More important than Yahoo! (Nasdaq: YHOO  ) , Google (Nasdaq: GOOG  ) , AOL (NYSE: AOL  ) , or CBS' (NYSE: CBS  ) Interactive Group. But don't take my word for it. According to comScore data, The Social Network accounted for roughly one-third of all online display ad impressions during the first quarter. No one else got close:


Display Ad Impressions*

Share of Impressions 346,455 31.2%
Yahoo! sites 112,511 10.1%
Microsoft (Nasdaq: MSFT  ) sites 53,592 4.8%
AOL 33,454 3.0%
Google sites 27,993 2.5%
Turner Digital 18,050 1.6%
Glam Media 10,207 0.9%
CBS Interactive 9,208 0.8%
Viacom (NYSE: VIA-B  ) Digital 9,051 0.8%

Source: comScore. * Numbers in millions.

History makes these numbers even more extraordinary than they might seem. Facebook's 346 billion first-quarter display ad impressions exceeded its entire 2009 count by 16 billion. Meanwhile, that year's market leader -- Yahoo! -- is currently on pace for 450 billion display ad impressions, a 14% decline.

The one rule not even Facebook can break
Skeptics will say, rightly, that seedy affiliates are partly responsible for the ads you see. It's also hard to know how effective Facebook pitches really are. Trouble is, you could say the same about Google. Both companies nevertheless continue to take in billions in revenue. What makes Facebook particularly appealing to advertisers is the audience it attracts -- 500 million strong at last count.

Apply the 80/20 rule -- as in, 20% of the population accounting for 80% of the activity -- and that's 100 million active users accounting for 560 billion minutes of activity, or about four days' worth of time on Facebook every month.

Going by the same math, it stands to reason this same population helped generate $1.6 billion of Facebook's estimated $2 billion in revenue last year. Advertisers paid just $16, or $1.50 monthly, to engage with this highly engaged group. No wonder analysts expect The Social Network to double revenue in 2011. Ad buyers are paying too little for access to an audience that rivals the viewership of the highest-rated U.S. television show of all time. (Care to guess which show? I've got the answer at the end.)

Problem, meet opportunity
Bearish investors will tell you that these numbers, too, are misleading because Facebook ads underperform other forms of display advertising. According to researcher Webtrends, Facebook performed half as well as alternatives and worse last year than in 2009. (The average click-through rate dropped from 0.063% to 0.051%, Webtrends says.)

Yet this is good news for investors. Why? Ad spending on Facebook more than doubled last year. If social ads are proving to be this attractive now, imagine what happens when The Social Network's Groupon alternative and location-based ads begin to really take hold. Prices will go up, margins will increase, and cash will flow.

And that's exactly what analysts are expecting. Bloomberg cites an anonymous source that says Facebook is on track to generate more than $2 billion in EBITDA this year.

Thus, at its latest valuation of $65 billion, Facebook trades for between 30 and 40 times projected EBITDA. Sound big? I suppose it is, but Capital IQ tracks 18 other software and services companies to have traded in the same range over the past year, including cloud computing infrastructure specialist Informatica.

So while I get the hysteria that comes with valuing Facebook higher than Boeing (NYSE: BA  ) -- a poke over a plane -- this pre-IPO stock isn't anywhere near as expensive as the arm-wavers would like you to believe. If anything, it's still cheap.

Do you agree? Disagree? Let us know what you think about Facebook's valuation, competitive positioning, and role in transforming social media from a pastime into a long-term investing opportunity using the comments box below.

The Motley Fool recently introduced a free My Watchlist feature that allows users to stay ahead of the curve and keep up to date on how Google and others are faring in the fight against social media upstarts. Add these companies to your watchlist today:

The 1983 finale of the hit comedy series M*A*S*H was the most-watched in U.S. television history, reaching more than 105 million households. Facebook probably has just as many diehards engaging with its pages daily.

Google and Microsoft are Motley Fool Inside Value picks. Google is also a Motley Fool Rule Breakers recommendation. Yahoo! is a Motley Fool Global Gains selection. Motley Fool Options has recommended members create a diagonal call position in Microsoft. Motley Fool Alpha LLC owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. 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 owns shares of Google, Microsoft, and Yahoo! and has written Apple puts. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy is a pre-dawn achiever.

Read/Post Comments (5) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 10, 2011, at 3:59 PM, bottomfisherman wrote:

    Social networking is grossly over-valued and little more then a fad. Facebook IPO will draw lots of attention make the owners a lot of money and dissappoint shareholders, shorts are going to have a field day with them.

  • Report this Comment On May 10, 2011, at 4:13 PM, DoubleMensa wrote:

    To those who suggest that social networking is a fad, you may want to remember that was the same refrain bellowed by some about computers, the internet a few years ago, and e-mail. Those wishing to look even further in the past may be aware of the man with reins in his hand saying that automobiles are just a phase.

    I recently had an investor with $1M cash contact me saying he liked reading my blog and wanted me to discuss my real estate investments with him. BTW: I said: "Yes" and feel I'm likely to say Yes! again in the's not a fad.

  • Report this Comment On May 10, 2011, at 8:03 PM, Borbality wrote:

    I think the real problem with a Facebook IPO is that to make the site more profitable, you're probably going to have to compromise the user experience.

    Facebook is huge because it's easy and does what you want to do. People don't go there because they want to buy crap. They want to see what their friends are saying. If you get in the way of that too much, you'll see them abandon the site for something better.

    It's possible that facebook could figure out a way to do it, but once wall street expectations are involved, I have a feeling the site will get less and less attractive and something better (or more like the old facebook) will take over. There's nothing really forcing people to stick around.

  • Report this Comment On May 10, 2011, at 9:33 PM, CaptainWidget wrote:

    Borb nails it. The reason it prospered (and killed it's competitors) was precisely because it was under-monetized. The perfect confluence of a an owner who only cared about his product and still manged to find enough funding to take his product out to the world.

    Facebook is popular because it's all about social interaction. Once they start dropping pop up ads onto your wall or hyper-linking amazon links into your status updates, another newer-hungrier competitor will eat it alive.

    For now, Facebook's moat is lots of people and an unobtrusive experience. Myspace had that too, and as soon as the latter disappeared, so did the former.

  • Report this Comment On May 11, 2011, at 9:41 AM, hheiserman wrote:

    Social networking is grossly over-valued [**possibly] and little more then a fad [**no!]

    Social networking facilitates one of our most basic human needs/wants: self-expression and the urge to communicate with others. Saying social networking is a fad is like saying that singing is a fad, or that the letter, telephone, and e-mail is a fad. Only a misanthrope :) wsould make this claim.

    Also, Facebook may have one of Morningstar's four types of competitive advantages: network effect. The more family and friends that join, the more time you spend on the site. Time will tell.

    Tim - "Poke for planes." Clever line.

    **Motley Fool - Please add spelll check and 'track new comments' functionality to this board, like Seeking Alpha.

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