Facebook is the largest social network in the world with more than 900 million monthly active users. It competes primarily with much smaller competitors like Google+, Twitter, LinkedIn (NYSE:LNKD) and Pinterest in the social networking space, and with Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT) and Yahoo (NASDAQ:YHOO) for online advertising dollars. Facebook made a net profit of close to a billion dollars in 2011, which is expected to grow further going forward.
Here are some of the key trends which are expected to significantly impact Facebook’s value going forward.
Display and text link advertising were the first types of advertising in the early days of the internet. However, Google then came up with search advertising which targeted ads based on search queries by users, improving the relevance of the ads greatly, driving click-throughs and conversion rates and providing much more value to advertisers and publishers alike.
Facebook, on the other hand, may have an even better advertising solution at its disposal – social ads. It offers a self-serve advertising platform for advertisers, which enables them to create text ad units and target them to users based on their social demographic data like age, sex, location, keywords, education level, workplaces, political views and relationship status. It is also rolling out new types of display ad units like custom fan pages, sponsored stories etc., which could turn out to be significantly more lucrative than search advertising going forward.
The virtual economy
In 2011, Facebook generated around $557 million through the sale of virtual goods on its website. We expect Facebook’s virtual goods revenue to increase steadily in the coming years, driven by both an increase in the average virtual goods spend per Facebook user and the increase in Facebook’s active user base. Thanks to its massive reach, Facebook is one of the most lucrative platform for app and game developers. Facebook currently takes a 30% revenue share off transactions powered by Facebook Credits. It may have to lower its cut going forward, but we expect the increasing virtual transaction volume to more than compensate for that.
Facebook makes money primarily from text and display ads and virtual transactions on its platform. However, we expect it to tap into yet another lucrative market to generate additional revenue going forward – social e-commerce.
Socially powered e-commerce is related to online physical goods sales which are driven through social media, specifically sales generated through social media referrals or links shared on social networks. Social commerce sales could also be driven through online storefronts set up by businesses on Facebook, to leverage their fan base to generate sales. The global social commerce market is expected to grow from $5 billion in 2011 to more than $30 billion in 2015. We expect Facebook to drive a significant portion of social commerce transactions.
Growing mobile usage
The increase in mobile and smartphone penetration across the world has led to a significant number of Facebook users logging in to the platform from their mobile devices. In a recent amendment to its IPO filing, Facebook states that the increase in Facebook usage on mobile devices has impacted the average number of ads delivered per daily active user, primarily because it cannot deliver as many ads as it does in the web interface on its mobile interface. It is still trying to figure out an effective monetization strategy for mobile, but no one, not even Google, has been able to completely crack the mobile advertising puzzle yet.
This could turn out to be one of Facebook’s greatest growth opportunities, as well as one of its largest threats if it fails to figure out how to crack the mobile monetization puzzle. We expect it to eventually figure out a way to deliver highly targeted and relevant ads to its mobile users using the social and location information at its disposal, boosting conversion rates and delivering more value to advertisers. However, if it fails to do so, that would mean lower ad revenue despite an increase in engagement on its platform.
We have a $82 billion Trefis valuation estimate for Facebook, which translates to a $33 Trefis price estimate based on its diluted share count.