Is Facebook the next Google?
Is Facebook’s IPO about to burst the social media bubble? In its first week as a publicly traded company, Facebook has gone from the most anticipated IPO of the last few years, to an almost outcast, as more news emerge on the days leading to its IPO. For the past few weeks, I have been poring over Facebook’s S-1 and Google’s S-1 and annual reports from the past few years. Why, may you ask? It’s simple: Because in my view Google is the closest competitor Facebook has today, and I wanted to analyze their relative performance. For starters, I do realize that many of you will consider this comparison anathema, as Facebook is a web 2.0 social network, as Google is such an old web 1.0 search engine. However, the reality is that while the value proposition for their users (people like you and me) is different, their business models are still fundamentally the same:
Get as many ‘eyeballs’ as you can on your platform, and monetize them (mostly) through advertising.
In order to make an apples-to-apples comparison, I focused most of the analyses on similar periods in their lifecycle, namely years 4-8 (2002-06 for Google and 2007-11 for Facebook).
As of Friday’s IPO, Facebook’s valuation, was 2.1x that of where Google was when it was 8 years old
While this gap has since closed somewhat (Facebook’s market capitalization is now hovering around $90 billion, down 13% since last Friday), the premium is still 1.9x that of Google.
But I am getting ahead of myself, let’s look at the similarities first…
- Revenue growth rate: Both grew at an astounding 122% compound annual growth rate over years 4-8.
- International diversification: By the end of year 8, they both relied outside the US for more than 40% of their revenues.
- Margins: Both their net and operating margins almost converged by year 8, although Facebook started from a very different place in their 4th year. Sometimes I wonder what Sheryl Sandberg’s influence has been in this eerily similar performance. She has been Facebook’s COO since 2008 and had spent the previous 6.5 years at Google, laying out many of the same underlying processes during Google’s early explosive growth years.
Now, what about the differences?
- Absolute revenues: Despite the fact that they both grew at the same compound growth rate during years 4-8, Google was ~3x the size of Facebook by the end of year 8 ($10.6B vs. $3.7B). Google grew much faster than Facebook in their earlier years (e.g., Google hit $1B in revenues in 5 years, while it took Facebook 6.5 years). (+1: Google)
- Advertising revenue dependency: Google was (and still is) significantly more reliant on advertising, as it depended on it for 99% of their revenues, while ‘only’ 85% of Facebook revenues were derived from advertising (12 of the remaining 15% comes through Zynga). While at a first glance Facebook appears to have been able to diversify their revenue stream earlier, Google did not have a single customer / partner accounting for 12% of their revenues. (+1: Unclear)
- Advertising revenue efficiency: The advertising industry uses ‘intent targeting’ to denote instances when people are expressing their specific intent (e.g., when running a Google search). This is typically not the case for Facebook, as people are not necessarily looking for a product when on the platform. As a result, their demographically-targeted ads are focused higher at the conversion funnel, an area still dominated by offline media. The implication is therefore that Google’s ‘eyeballs’ are a lot more valuable as a result. This and that study I recently saw show that Google’s click-through-rates are ~10x that of Facebook. I have not seen any more extensive studies, but if you have, I would love to see them. (+1: Google)
- Operating cost structure: First of all, Google's cost of revenues is significantly higher than that of Facebook, accounting for 40% of their revenues (as opposed to Facebook’s 23%). The primary difference is Google’s traffic acquisition costs they pay to their Google Network members as part of AdSense (if you back that part of the business out, cost of revenues drops to 14%). At the same time, Facebook spent 10% of their revenues on Marketing & Sales, as opposed to Google's 7%. In addition, Google outspent Facebook on R&D by more than 3.4x, accounting for 9% of their revenues as opposed to Facebook's 7%. (+1: Google)
- Network structure (i.e., walled garden vs. open): This has been an area of much heated debate over the past few years, with many people comparing today’s Facebook to the 1990s AOL (and we all know where AOL is today). Sergey Brin gave this interview last month at the Guardian, and while it may appear self-serving, many of the points are valid I believe. While Facebook now has over 900M users globally, their much-touted social graph is still a closed graph, and I believe this might be their Achilles heel. (+1: Google)
Google has continued to grow at a respectable 23% compound growth during the past 5 years to almost $38B in revenues last year, and is still commanding a healthy 26% net margin. As of today, Google is worth $187B, with a P/E ratio of 18.
In their amended S-1 filed last week, Facebook reported Q1 revenue of $1.058B, up 45% YoY, although their Average Revenue per User (ARPU), a closely-followed metric only grew 6%. So, even after the 13% share price drop since last Friday, is Facebook still worth $90B? Only time will tell, and although I do not believe so, I said the exact same thing during Google’s IPO in 2004, so please don’t take my word for it.
PS. I also ran these analyses accounting for inflation, but the results did not fundamentally change and hence decided to stick to non-inflation-adjusted figures for simplicity.