Facebook competes with large internet search and media platforms like Google (NASDAQ:GOOG), Yahoo (NASDAQ:YHOO) and AOL (NYSE:AOL) to capture the attention of internet users as well as drive views of online advertising.
We recently launched coverage of Facebook with a valuation of $45 billion. See our launch article 4 Key Businesses That Determine Facebook’s Valuation for additional details on how our valuation for Facebook compares to others. Although our valuation is below that of the $50 billion valuation at which Goldman Sachs (NYSE:GS), Digital Sky Technologies and selected Goldman Sachs clients invested in January 2011, we highlight below how the key drivers of Facebook’s value could potentially improve, leading to an even higher valuation of $100+ billion for Facebook.
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Scenario #1: Facebook’s Revenue per Page View from Text & Display Ads Doubles
Social networking sites are mostly used for communication (and voyeurism) rather than seeking information on products and services. What this means from a business perspective is that many people are still starting at google.com when they’re trying to book an airline ticket rather than facebook.com so the big ad spenders (like airlines) are still on Google.
A key metric for internet businesses is how much money they make per page view or per search. In the case of Facebook, we estimate that its text and display ad revenue per page view (RPM) was about $0.38 per 1,000 page views in 2009 and about $0.45 per 1,000 page views in 2010.
We expect Facebook’s Ad Revenue per Page View (RPM) to increase as ad targeting on Facebook improves, more ad dollars shift online and online ad dollars shift to Facebook as the company’s presence widens. However, we believe that faster Facebook RPM growth will be partially offset by a rising mix of Facebook users in emerging markets where online ad rates are typically lower than the US and Europe.
However, if Yahoo and AOL are any indication, it’s possible to achieve RPM rates of $1 to $3 per 1,000 page views on large (portal) media sites. Yahoo (at about $1) is the better benchmark in the case of Facebook since it has a larger international mix than AOL. If Facebook we’re to achieve comparable text and display monetization rates as Yahoo has today, then that would add about $35 billion of upside to our current valuation of Facebook.
Scenario #2: Page Views per User on Facebook Increase by 50%
As suggested above, ad-based internet businesses like Facebook are driven by the number of dollars per page view. So how do you make more money? Increase the dollars per page view and increase the page views. We’ve talked about one, now let’s see what Facebook can do to increase the number of page views.
We estimate that Facebook currently gets about 415 page views per user per month on average. This is a phenomenal amount. It implies nearly 14 page views per user each day. Given how high Facebook’s page views per user currently are it may be tough to increase page views significantly, but Facebook has figured out ways to do it in the past.
Remember pre-2009 when the Facebook profile was just one page? Then Facebook started to break-up the profile page into tabs like “Wall”, “Info”, “Photos”, “Notes”. Each time you toggled to a new tab, the ads on the right-hand side refreshed meaning a new page view and ka-ching for Facebook.
Facebook recently rolled out a new design that relegates the tab behavior to below the main profile photo and instead promotes previews of user photos to the top of the page – the prime page real estate. You don’t put something on that part of a webpage unless you want someone to notice it and noticing photos makes you more likely to click them. Clicking such a photo on Facebook drops you into the user’s photo album where you can easily cycle through one photo after the next while ads appear to the right. It turns out that users have many more photos than there were tabs and since the number of photos on a person’s Facebook profile is generally cumulative, that could mean ka-ching, ka-ching, ka-ching for Facebook.
Furthermore, smarter photo recognition and tagging could blow the doors open on contextual advertising. Staring jealously at that photo of your friends smiling in front of the Eiffel tower? Oh, what’s this special deal to Paris from Delta about? While Google leads in capitalizing on intent, Facebook could potentially capitalize on much more powerful reactions.
And photos are just one way to keep you cycling through Facebook. The company is also introducing (1) e-mail (think of each e-mail as a new page) (2) HD video and better video integration (3) more third-party applications like games.
If Facebook’s page views per user were to increase 50% over our forecast period, the impact of that combined with scenario #1 would lead to a $100 billion valuation for Facebook.
Scenario #3: Facebook Captures 10% Search Market Share
We estimate that Facebook had about 2% global search market share in 2010, higher than that of AOL. We currently expect that Facebook’s search market share will grow to more than 5% by the end of Trefis forecast period and be comparable to Yahoo’s share.
Facebook’s partnership with Microsoft gives Facebook the search technology to compete better with search players like Google and AOL. If Facebook can take some search market share away from Google and reach about 10% share by the end of Trefis forecast period, there could be an upside of 10% to our valuation for Facebook.
Scenario #4: Games & Applications Revenue per User Doubles
Games on Facebook like FarmVille have helped generate additional revenues for the company. We estimate that Facebook Credits, Facebook’s virtual currency used for purchasing virtual goods in games and applications, generated about 85 cents of revenue per user in 2010. Facebook earned a 30% profit on these revenues.
As the number of games and applications increase on Facebook platform, we believe more users will be attracted to playing games and using applications. Zynga, the leading developer of Facebook applications, has made popular games like FarmVille and Mafia, and Facebook will continue to benefit from rising use of such popular games.
We estimate that Games & Applications revenues per registered user will increase to about $2.60 by the end of the Trefis forecast period.
There could be an upside of about 25% to our valuation for Facebook if Games & Applications revenue per user increases to around $5 by the end of Trefis forecast period.
If all four scenarios outline above were to materialize, it would imply a valuation of about $125 billion for Facebook based on our analysis.
The Social Ad Network
Could Facebook have even a few more billion up its sleeve? So far we’ve focused on money that is expected to be made directly on Facebook’s platform. Have you noticed the integration of Facebook with sites like the New York Times and Huffington Post? Such integration is not just an opportunity to drive more traffic to Facebook but presents a long-term opportunity for Facebook to introduce what we’ll call the “social ad network” whereby Facebook places social ads (think sponsored Like buttons) on third-party sites and splits the ad revenues with those sites.
Facebook competitors Google and Yahoo are already in the third-party ad network business. For Google, we estimate that its third-party ad network accounts for about $10 billion of the company’s value. This could be another meaningful business for Facebook that we currently do not show in our analysis.