Facebook – king of the internet or the next MySpace?

Investors are putting millions into the social networking site, but will the risk be worth it? Laura Chesters reports

Sunday 09 January 2011 01:00

'Your Facebook page is your interface with the universe," declared one analyst last week following Goldman Sachs swoop on the social-network site.

And it is an enormous universe. Facebook already has more than 500 million members, with users speaking 75 languages and spending 700 billion minutes per month on the site. But the big question is whether Facebook is the next Google and Amazon or the next MySpace or Bebo.

Goldman Sachs invested $450m (£290m) in the social networking site while an existing shareholder, the Russian investment firm Digital Sky Technologies – set up by two former Goldman directors – invested another $50m, valuing Facebook at an astonishing a $50bn. This makes it worth more than corporate giants such as Boeing, Kraft, Diageo, Mitsubishi and Credit Suisse.

So how did a young, private company with £2bn revenue get valued at such a vast amount? Are we seeing the next dotcom bubble or are social networking sites about to make big profits?

Goldman is clearly betting on the latter. Analysts reckon the investment bank has made the first strike, aiming to float Facebook next year. But the $50bn price is too big for some to swallow.

Scott Kessler, a technology analyst at Standard & Poor in New York, said: "Candidly, this is a huge valuation for a company we know little about. It has $2bn of revenue so we are looking at 25 times multiples of sales. By contrast, Google trades at a discount to this at 25 times earnings. That puts Facebook at a tremendous premium to Google."

But Mr Kessler admits advertising is the key. "Facebook has put together a social graph putting together a unique and powerful set of data for advertisers. More and more people using Facebook use it as the hub of their activities online or through mobile devices – from games to meeting friends, and soon there will much more."

Advertisers are already acutely aware of what access Facebook can provide and they are willing to pay good money for it.

Jass Sarai, PricewaterhouseCoopers UK technology leader, says: "The size of the investment in Facebook is an indication of how valuable intimate details of individuals can be to advertisers. Google can target advertisements based on the kind of searches an individual makes. But on each of our Facebook pages are all our likes and dislikes – what we are doing and what we want to do. The internet was the platform but now social media is the next platform. This is about hyper-personalised sales."

Niki Dixon, a partner specialising in technology at Grant Thornton, says: "When Facebook first started to use advertising there was a resistance by its original users, but now that there are so many people using Facebook and Facebook has developed its techniques there is no longer this resistance. Advertisers are seeing a good conversion rate of customers via brand pages."

One Facebook fan, Lou Kerner, a social-media analyst at US-based Wedbush Securities, says that Facebook is "the transformational media company of our time". Facebook should be viewed as having the same importance and reach as broadband.

Mr Kerner adds: "I believe in the $50bn valuation. I believe Facebook could be valued at $100bn or even $200bn could be a modest valuation. Facebook isn't without risk, of course, but it has nearly 600 million members with more than two billion people using it in some form. But we are still at the very beginning. Soon the majority of users will enter via android and mobile devices in the future and it will be the singular network that people connect to."

But it is not just advertising that is the key to Facebook's profitability. It is the potential of its other revenue streams that has Goldman and its investors so excited.

Facebook credits are a key element of potential growth. These credits are something that a member can buy with a credit card or via PayPal, which are then spent inside the Facebook network. Currently the main use is gaming. Facebook's biggest game provider, Zynga, takes credits and these can be used to buy things for its popular Farmville game.

But some analysts believe the growth of this could become far wider if Facebook created more of its own games. Some predict that eventually Facebook credits could become currency to buy actual real-world products via the Facebook network.

Mr Sarai says: "It is conceivable that we could see Facebook start becoming a retail bank via its credit scheme. People could eventually do all their online shopping through Facebook using its credits."

Mr Kessler says: "Gaming is an obvious area where we will see the continued use of credits and micro payments. But we could also see cash exchanges taking place via Facebook credits such as betting. Facebook could even develop its own PayPal system. The possibilities are endless."

Another large growth area for its investors is the internet search facility. This is one market Google has pretty much sewn up so far, beating rival Yahoo!. But Facebook could directly compete with Google in the future.

How Facebook could eventually grow is mind boggling, but what are the risks? Facebook might be the latest wonder, but people have also thought many other social networking sites before it were the next big thing.

MySpace was bought by media mogul Rupert Murdoch for $580m in 2006. It is now struggling to live up to its once heady expectations and will be sold or restructured. Bebo, aimed at the teen social network market, was sold by AOL last year to turnaround specialists Criterion Capital Partners for a figure rumoured to be less than $10m. AOL had paid $850m for Bebo nearly three years ago.

Facebook, despite all its merits, still has some analysts concerned. With the rise in advertisers accessing people's information, some Facebook members may become agitated and worry about the security of the network. Google has already become a much criticised business on privacy laws, with Canada's data commissioner, Jennifer Stoddart, leading the charge on patrolling the use of personal data.

The predicted stratospheric growth of Facebook advertising also worries analysts, as it could be compared with the growth predicted for mobile phone advertising. Experts and analysts have long been predicting the rapid growth of mobile advertising, but recent statistics by Enders Analysis show that it is only this year that the sector will become a significant segment of the digital media market, having failed to live up to expectations until now.

Julia Reynolds, the chief executive of online retailer Figleaves.com, says Facebook could still be a fad. "Many of the 15- to 18-year-olds I speak to are jaded with Facebook. I am not convinced it is the next big thing as it could still be just a fad. Its growth is likely to be in the developing world rather than in the UK and the US as the internet is so saturated here."

Despite the pitfalls that could lie in wait for Facebook, there is no denying the sheer scale of potential growth. Mrs Dixon says: "The contrast between Facebook and other social networking sites, such as Bebo and MySpace, is the number of people now on it. Despite some issues it has encountered in Asia Pacific, the sheer numbers show that Facebook dominates unlike anything else. Now it has diversified it is not a one-trick pony. It is becoming all encompassing."

What does the growth of Facebook mean for other new social media businesses? Mr Kerner believes they will also grow but not as fast. "Facebook is the singular network to connect to your friends. Twitter is how to connect to people who are not your Facebook friends. We also think LinkedIn will have some penetration but below that of Facebook and Twitter. But it is still early. We see there will be incredible growth in the gaming sector and we predict a new gaming network that could be established or grow."

The latest site to gain traction is Quora, a question-and-answer service where fellow users attempt to answer questions posed. The site uses Twitter-style following to track the best contributors of answers. It was founded in 2009 by former Facebook staffers Charlie Cheever and Adam D'Angelo, and is reported to have more than 500,000 users.

Twitter has already been gearing up to make a profit. In the past six months it has hired people to look at growing revenue streams and has hired a president of revenue.

So what does the future hold? What is Facebook going to do with the new capital it has at its fingertips – not just the $500m invested last week but a further $2bn being raised by Goldman from new investors?

Experts suggest the money will be spent on growing the advertising models, the credits and gaming platforms and hiring new people to work on these areas. Facebook is competing with the likes of Google which has tremendous access to capital, and now Facebook is playing in the same league with a similar access to capital.

The growth of Facebook isn't just about Facebook. It is also about all the other companies trying to grow their own businesses via social networking sites – whether they be retailers, consumer goods companies or global service companies. Mr Sarai says: "This is as much about technological innovation as it is about consumer needs."

It is still unclear exactly when Facebook will go public. Its founder, Mark Zuckerberg, consistently says "not yet" and plans to improve the profitability of the company first.

But Zuckerberg's big game plan has always been more about changing the way the world interacts to make it a "better place". If he succeeds in doing so he would make Goldman and a lot of other investors very rich indeed.

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