5 Reasons Facebook Stock May Be a Better Buy Than You Think

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FacebookFacebook may be a free website, but that doesn't mean it will be a cheap investment.

Many analysts feel that by taking this long to go public, the leading social networking website will be priced too dearly for growth investors. If Facebook hits the market at the high end of its proposed valuation, where does a company with a $100 billion market cap go from here?

Google (GOOG) has been a seven-bagger since going public eight years ago -- soaring from $85 at its IPO to more than $600 today -- but the world's leading search engine also began its publicly traded life with a relatively modest $20 billion market capitalization.

Cynics are worried about the starting line.

However, what if Facebook isn't actually outlandishly priced? What if $100 billion is actually a reasonable price for a company that has taken the Internet to an entirely new level? Let's go over a few of the reasons Facebook may be cheaper than worrywarts are leading you to believe.

IPO1. What 845 Million Users Are Worth Will Change

Analysts often make the mistake of boiling this down to eyeballs. They divide $100 billion into Facebook's 845 million monthly active users and wonder if Facebook is truly worth $118 per user.

On the surface, it isn't. Facebook generated $1.1 billion in revenue in its most recent quarter, giving it a revenue run rate of $4.4 billion over the course of a year (it actually generated $3.7 billion in revenue for all of 2011, but it started out with a much smaller base of users to make this a fair comparison). In other words, Facebook is generating a little more than $5.35 a year in revenue on every user.

Run Facebook's net income of $302 million during the holiday quarter through the same run-rate math and Facebook is earning roughly $1.43 a year in revenue on every user.

No one would pay you $118 a head for that kind of business, but we're forgetting a few things.

  • Facebook is still growing. Its user base has more than doubled over the past two years.
  • Revenue is growing faster than Facebook's user base. Revenue has actually popped nearly fivefold during the two years that Facebook's active audience has doubled. A combination of better monetization and users spending more time on the site make this a growing metric.
  • As friend connections grow -- and there are already 100 billion friend connections on Facebook -- the site's user base will grow and so will the time they spend on the site.

In other words, $5.35 a year in revenue and $1.42 a year in earnings isn't the ceiling. We're still at the floor.

2. Corporate America May Be Willing to Pay Up

Despite the email hoaxes that make their rounds every few months, Facebook will always be a free website for users. If this is the model that made Mark Zuckerberg a multibillionaire, do you really think he's going to mess with it?

There may come a point at which offering a premium version of the site -- along the lines of $20 a year for an ad-free experience -- may make sense, but the low-lying fruit here is to go after the countless corporations that set up brand pages on Facebook for free.

Companies are slashing their marketing spends as a result of broadcasting through Twitter and Facebook. It's free as long as they don't want to spend on ads to promote their presence. Do you think that will last forever? Just as Facebook makes sure that it gets a piece of the action from app developers making money on its website, it won't be long before the social networking giant either begins charging larger companies with commercialization intentions for access or begins offering a premium platform to make it worth their marketing dollars.

3. The Next Zyngas Are Coming

One of the more surprising nuggets in Facebook's paperwork to go public is that 12% of its revenue last year came from social gaming giant Zynga (ZNGA).

Between payments processing fees related to Zynga's sales of virtual goods in its games and direct advertising by Zynga to get noticed, Zynga and Facebook have created a great win-win symbiotic relationship.

If a small company can grow to become so important on the heels of Facebook, Mafia Wars, and Words With Friends, why can't there be more budding Zyngas out there? There are -- and there will be.

4. Social Networking May Be the New Search

Google didn't roll out Google+ last year because it was bored. The world's most valuable dot-com realizes that Facebook can potentially eat into its business.

Before Facebook, Google made sense as the launching point of any search. Need a new dentist? Can't remember if it was Dermot Mulroney or Dylan McDermott in that movie you saw last week? Want to see what you can do this weekend? Big G could lend a hand.

However, many of these same queries can also now be posed right on Facebook as a status update. The response may not be immediate, but it will come from someone you know and possibly trust.

Google has blossomed into a $200 billion company largely on the strength of its ability as a search and online advertising company. What if Facebook can do this even better?

5. Madison Avenue Is Calling

Facebook angered privacy rights activists when it rolled out Beacon in 2007. Facebook -- a lot smaller at the time, of course -- teamed up with 44 consumer-facing companies to begin sharing actions on the site. A visit by a Facebook user to the websites of Blockbuster, TripAdvisor (TRIP), Fandango, or any of the other partners allowed users not only to broadcast their actions through Facebook, but also to let advertisers do a better job of targeting their marketing.

Beacon itself was shelved under a cloud of controversy two years later, but clearly there is marketing value to the likes, preferences, and actions of Facebook users if it's done in a fair and sensitive manner.

Can it get too creepy? Sure. If you click "Like" on a new Tom Hanks movie or stream Lady Gaga you may not appreciate that going out to your friends as ads to buy movie tickets or digital downloads. There has to be a balance here. However, if someone is going to reinvent online advertising -- taking it to a more effective, personal, and accountable level -- is there anyone that could do it better than Facebook, given how well it now knows you?

You may think it's straddling the fence on ethics, but Facebook's sitting on a goldmine of consumer data. It just needs to figure out when and how to start mining.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any stocks in this article. The Motley Fool owns shares of TripAdvisor and Google. Motley Fool newsletter services have recommended buying shares of Google.


5 Reasons Facebook Stock May Be a Better Buy Than You Think

Oct. 28, 2003: Mark Zuckerberg hacked into restricted areas of Harvard University's computer network to create Facemash, a website that pulled the private dormitory ID photos of students, then asked users to compare the pictures of two random students and chose which one was better looking. For the brief period before university administrators shut it down, it proved quite popular.

January 2004: Zuckerberg began to write the basic software to create a universal Harvard social directory, TheFacebook.

Jan. 11, 2004: Zuckerberg registered thefacebook.com domain. Then, on Feb. 4, TheFacebook launched at Harvard University. Mark Zuckerberg, right, and Dustin Moscovitz, co-founder, left; took a semester off in 2004 to further improve on TheFacebook website.

March 2004: Initially restricted to Harvard students, TheFacebook expanded to other colleges, including Stanford University, Dartmouth College, Columbia University and Yale University.

April 13, 2004: Zuckerberg, Dustin Moskovitz, and Eduardo Saverin formed Thefacebook.com LLC, a partnership.

June 2004: TheFacebook moved it's headquarters to Palo Alto, Calif., and received an investment of $500,000 from Peter Thiel.

June 2004: Thefacebook incorporated into a new company, and Sean Parker, a co-founder of Napster, took the job of president for the growing business.

September 2004: Facebook replaced its "User is..." prompt with a "What's on your mind?" question in the newly designed space for posting and sharing status updates called "The Wall." 

September 2004: Harvard students Cameron Winklevoss and Tyler Winklevoss of ConnectU filed a lawsuit against Zuckerberg and other Facebook founders for allegedly stealing their idea for a college social network called HarvardConnection.

July 19, 2005: Then-dominant social networking site MySpace was acquired by News Corp., spurring buzz on the Internet about the possible sale of Facebook to a larger media company.

Aug. 23, 2005: TheFacebook dropped its "The" and became Facebook. Purchase price it paid for the Facebook.com domain name: $200,000.

September 2005: Facebook added networks for high school students.  In December 2005, Facebook reached 6 million users.

2005:  Artist David Choe began painting murals at the headquarters of Facebook in exchange for company stock. Today, the shares he received are worth an estimated $200 million.

2006: A cash flow statement was leaked showing that Facebook had a net loss of $3.63 million for the 2005 fiscal year.

Sept. 26, 2006: Facebook removed its restrictions and allowed anyone 13 and older with a valid email address to join.  A news feed and a mini-feed were introduced, providing easier ways to see what your friends are up to.

May 2007: Facebook Platform launched with 65 developers and more than 85 applications.  Third-party developers quickly followed, building applications to integrate with Facebook. Games such as Farmville and Mafia Wars spread rapidly.

July 25, 2007: A federal judge gave twin brothers Cameron (left) and Tyler Winklevoss, founders of ConnectU, and Divya Narendra until Aug. 8 to flesh out the allegations in their lawsuit against Mark Zuckerberg. Those charges  included fraud, copyright infringement and misappropriation of trade secrets.

December 2007:  Facebook reached 58 million users. With the successful addition of Facebook Platform and video, growth remained strong.  Facebook charted a course toward becoming a general portal like AOL; meanwhile, the choice was made not to aim toward being acquired, as   MySpace.com, YouTube and so many other tech startups were.

June 2008: Facebook settled two lawsuits, ConnectU vs Facebook, Mark Zuckerberg et al. and intellectual property theft, Wayne Chang et al., over The Winklevoss Chang Group's Social Butterfly project. The settlements effectively had Facebook acquire ConnectU for $20 million in cash and Facebook shares valued at $45 million, based on a $15 billion company valuation.

July 2008: The first Facebook iPhone app was released.

August 2008: News broke that some employees reportedly privately sold their shares to venture capital firms at prices that gave the company an implied valuation of between $3.75 billion and $5 billion.

October 2008: Facebook set up its international headquarters in Dublin, Ireland.

February 2009: The "Like" social plug-in was added, allowing users to follow status conversations without having to say anything.  The like button was instantaneously a hit. It's initial purpose has been widely misinterpreted as a positive approval button.

August 2009: Facebook acquired FriendFeed, a real-time news aggregator.

September 2009: Facebook said that its cash flow had turned positive for the first time.

April 2010: Facebook announced the acquisition of photo-sharing service Divvyshot, and introduced Community Pages.

May 31, 2010: Quit Facebook Day was an online event where users vowed that they would quit the social network shortly after widespread criticism was received on the new privacy controls rolled out in mid-May.  Zuckerberg publicly admitted the company had "missed the mark."  An estimated 33,000 users quit the site.

June 2010: Facebook employees sold some shares on SecondMarket at prices giving the company an implied valuation of $11.5 billion

August 2010: Places launched, allowing users to share information about where they are in the real world, so friends can find each other.

Oct. 1, 2010: The Social Network, a film about the start of Facebook, was released to theaters. The film, directed by David Fincher, was met with widespread critical acclaim and won the Golden Globe and Critics Choice Best Picture for the Year. Mark Zuckerberg stated that the film is an inaccurate account of what happened.

November 2010: Facebook added features to its mobile software for Android devices. The number of users reached just short of 608 million, with mobile traffic increasing.  

December 2010:  TIME magazine named Facebook founder and CEO Mark Zuckerberg the 2010 TIME Person of the Year.

January 2011: Equity investors put $500 million into Facebook for 1% of the company, placing its implied value at $50 billion.

February 2011: Facebook added 'Civil Union,' and 'Domestic Partnership' to its Relationship Status options.

February 2011: Facebook application and content aggregator Pixable estimated that Facebook would host 100 billion photos by summer 2011.

June 2011: Facebook partnered with Skype to add video calling as well as a new group chat feature.

September 2011: Heroku joined forces with Facebook for application development using the Facebook Platform.

Sept. 22, 2011: Facebook debuted the new Timeline user interface at the F8 Convention.

October 10, 2011: Facebook launched its iPad app.

December 2011: Membership reached 845 million users.

December 2, 2011: New York Mayor Michael Bloomberg (left) Facebook Chief Operating Officer Sheryl Sandberg (center) and Sen. Charles Schumer (D-N.Y.), react during a news conference on the announcement that New York will be the center of Facebook's new engineering technology initiative.

December 22, 2011: Facebook launched the new profile user interface, Facebook Timeline.

January 24, 2012:  Facebook announced that  "Timeline" would become mandatory for all users.

Feb.  1, 2012:  Facebook filed paperwork to go public, seeking to raise $5 billion on Wall Street in the largest flotation ever by an Internet company.

March 6, 2012:  Facebook launches Messenger for Windows, which gives users of Windows 7  Facebook services without the need for a web browser.

April 9, 2012: Facebook announced that is will acquire the photo-sharing app Instagram for $1 billion USD.

May 18, 2012: Facebook founder, Chairman and CEO Mark Zuckerberg, center, rings the opening bell of the Nasdaq stock market from Facebook headquarters in Menlo Park, Calif. The social media company priced its IPO on Thursday at $38 per share, and beginning Friday regular investors will have a chance to buy shares.

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