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Digital Tonto: In defense of Facebook

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June 11, 2012, 3:50 p.m. | Op-ed — by Greg Satell

Greg Satell

Digital media people can be an annoying lot. While the rest of the economy is mired in muck, the webheads are sailing through, minting money and making outrageous fortunes. There does seem to be something unfair going on. While most of us slave away at our Sisyphean careers, a bunch of twenty-something whiz kids become billionaires in a few short years and seem to be having a lot of fun while they’re at it. Where’s the justice?

So it’s not surprising that since the much-anticipated Facebook IPO has gone south, there has been an outpouring of schadenfreude. “I knew it all the time,” people say, thrilled that their doubts have manifested themselves ia a plummeting stock price. That’s silly and, for the most part, the criticisms are either dubious or wholly without merit.

The Myth of Virtual Goods



When I was growing up in Philadelphia, the swankiest restaurant in town was Le Bec-Fin, which offered a sumptuous 9-course meal for a fixed price of $100. I remember my friend’s grandfather saying, “I understand that the food is good, but you could buy 100 Big Macs for that. How could one dinner be worth 100 Big Macs?”

Many people, like conservative columnist Ross Douthat in this piece, are making the same argument about Facebook. They say that Facebook doesn’t sell anything real and therefore doesn’t deliver true value. Apple and Amazon, Douthat points out, sell physical objects and that, in his view, makes them worthwhile while Facebook is just “cheap fun.”

The argument should be ridiculous on its face and I’m surprised that Mr. Douthat would voice it. Many industries are based on intangibles. We regularly fork over $15 for a movie ticket when we can wait and watch it at home for free, just as we gladly pay $5 per beer plus a cover charge when we could just get drunk at home and listen to the radio.

In the final analysis, business is about making money and Facebook makes a lot of it, $3.9 billion last year. Oh, and Amazon? That “real economy” company has a truly “unreal” forward P/E ratio of 85 and a PEG ratio of nearly 6. Stick to politics Ross!

Giving it Away For Free



Another source of the carping is that Facebook “gives it away for free.” Many like to point out that companies can put up profile pages for nothing, so there’s no reason for marketers to pay to promote themselves? What a load of crap!

First of all, marketers invest serious money into developing those pages, just like they would any other owned asset. Web pages are also free, does that mean that nobody needs to buy any online advertising? Should Google start charging companies to be included in search? Of course not!

Second, most of the paid advertising on Facebook goes toward driving traffic to those pages. It is the fact that they are free which drives demand, especially from small advertisers. It’s a perfectly viable business model that, as I noted above, has attracted billions of dollars of advertiser investment.

Lastly, it’s important to remember that Facebook is still learning how to use Facebook, just like the rest of us. They have put forth some new ideas, likesponsored storiesand promoted posts, but innovation is a trial and error process, which takes time to get right. Google had similar issues in the early days.

The thing is, they only need to get it right once and that success will be multiplied by a billion users.

Facebook is a Poor Marketing Vehicle



A more serious point is whether Facebook works for advertisers. There are many who have doubts along the lines which The Ad Contrarian lays out in this post. Others point out that GM just pulled their entire budget from Facebook.

While these concerns are valid, I think they are vastly overblown. Facebook does indeed have very low click through rates, but with nearly a billion people spending a good part of their day on the site, even low rates add up to a lot of traffic.

Further, part of the reason Facebook has such low CTR’s is its relentless focus on user experience. This article suggests that the reason GM dropped its support is that Facebook wouldn’t allow them to do a page takeover. It’s that same devotion to users which makes the site such a strong platform for companies like Zynga, Spotify and SocialCam.

The strength of that platform opens up additional revenue opportunities and Facebook earned 15% of their revenues from non-advertising sources last year – over $500 million. In other words, enough to make Facebook a billion dollar company in its own right.

The Valuation



As I wrote in apost last year, when Goldman Sachs valued Facebook at $50 billion, the main component of Facebook value is expectations about how fast its business will grow.

There’s nothing wrong with that. The value of any business is thepresent value of future earningsand, because Facebook is a young company with a history of stellar growth, judgments about its prospects will vary widely. That means the price will be volatile.

The real situation is this: Facebook went public at a valuation of $104 billion, After a disastrous first week, it’s now valued at $61 billion, still enough to make it one of the most valuable media companies in the world. Its forwardP/E ratiostands at 44 and itsPEG ratioat 1.67, high but not outrageous.

Most likely, the price will bounce up and down quite a bit over the next few years and each time the pendulum swings, people will say, “I knew it all along.”

That’s theparadox of value. Prices fluctuate because people’s opinions fluctuate. So while I have no idea whether Facebook will turn out to be a good bet or not, I do know that much of the sanctimonious hand-wringing going on right now is not only unfair, but not particularly well thought out.

A Dose of Reality



The truth is that only time will tell if Facebook can meet the lofty expectations that many have for them. It’s a young company with many challenges ahead that needs to meet aggressive growth targets. Nothing is certain.

What I do know is that they have built an amazing business in a very short time and they have done it the right way. They have dominated a crowded field, been extraordinarily innovative, focused on users, partnered well and created an enormous amount of value for marketers.

So why are the vitriol? Why do the recent troubles with the Facebook IPO seem to give so many so much pleasure? Surely, it hasn’t stopped untold millions from enjoying the site over the past week, nor has it hampered their business prospects. They remain a profitable company growing at a fast clip.

The answer is simple. Some people are just nasty and petty.

Greg Satell is a U.S.-based independent media analyst.You can read his blog entries at http://www.digitaltonto.com
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