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.





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