Facebook (FB 1.91%) made history this July, when it announced a 53% increase in revenue. This was due to what most investors had erroneously identified as a threat: its mobile business. Since then, its share price has doubled. Since shares are trading at almost 200 times earnings, there's no doubt investors are very optimistic about Facebook's future. But can the social network justify this mesmerizing valuation?
The king of social advertising
To justify an outrageous valuation, Facebook needs to generate an enormous amount of sales. This can only be done by taking social advertising to its maximum expression. In order words, Facebook needs to take fully advantage of its more than 1.1 billion registered users, both directly, by showing ads, and indirectly, by successfully introducing new features and products. For example, Facebook Graph Search, which has been designed to give natural answers to queries rather than showing the usual list of result links, could become a disruptive force in the search engine space.
Facebook should also benefit from international expansion. There is plenty of room for geographical diversification, because the U.S. represents less than 20% of total traffic, but nearly 50% of overall revenue. International markets need to be monetized as much as the U.S. market.
Obviously, Facebook will need to remain as the most widely used social network. Preferably, most users with Internet access should have a Facebook account. In terms of competition, the industry should remain compact, which is likely considering there are high barriers to entry. Although developing your own social network sounds technically feasible and inexpensive, scaling it from one to one billion is nearly impossible.
The company should also use its ability to generate massive traffic to enter new segments, like social e-commerce, and launch innovative applications, just like Google did with its search engine. Acquiring promising start-ups could be helpful. For example, the acquisition of Parse, early this year, allowed Facebook to gain exposure to a new emerging segment -- paid tools for mobile app developers-- that could be worth as much as $100 billion by 2015.
Alternatives
Social networks will revolutionize the way we think about advertising. BIA/Kelsey has estimated that by 2017 the U.S. social media market alone will be worth $11 billion. But, if you want to get exposure to this promising new market, Facebook isn't the only choice.
With nearly 200 million users, Chinese social network Renren (RENN +3266.67%), offers exposure to a social network and to the second-largest economy. Although it is widely known as "the Chinese Facebook," Renren isn't an advertising company in terms of revenue sources. In the latest quarter, revenue came in at $46 million, with gaming as the main driver.
Renren is particularly skilled at taking advantage of its social network to promote its own game titles, and successfully launch new services. A great example is Nuomi, Renren's group-buying service. After seeing Noumi's sales increase over 100% year over year, Baidu decided to buy a 59% stake for $160 million. This shows how Renren can develop a $270 million new business in 3 years.
On the other hand, LinkedIn (LNKD +0.00%) could be the best monetized social network. Its main cash cow, the talent solutions unit, sells data and tools to corporate recruiters. But LinkedIn also sells ads by impressions, and premium subscription packages, ranging from $7 to $34 per month. However, due to increasing relevance of competitors, such as Viadeo, which is widely used in emerging economies, it may get increasingly difficult for LinkedIn to justify its nosebleed valuation.
Final Foolish thoughts
The bottom line probably lies in the real value of a user profile. After all, Facebook's most valuable asset is its 1.1 billion user base. One in seven people on Earth have a Facebook profile. With the world's population expected to reach 8 billion by 2025, and the increasingly relevant role of social networks for communication, Facebooks' user base could easily double by 2023.
Can each of Facebook's profiles be worth $150 or $200? Absolutely. Just in 2012, Facebook made $9.51 in ad revenue per user in the U.S. and Canada. This number is expected to increase significantly, and so is Facebook's value.
