Facebook The Business (Not The Stock)

Usually, when it comes to stocks with high growth rates, I don’t get to show my full appreciation for the business because the P/E ratio is something obscene (thus obliterating the margin of safety principle and deterring investment) so it sounds like I’m against the company even if I am impressed by its story, profit margins, and future. Facebook’s P/E ratio is 73, and you know what I think about that, but today I’d like to talk about the company’s business developments.

The long-term viability of Facebook is something that I’ve put in my “too hard” pile because I can’t figure out its moat. On one hand, I study the data that shows slight declines in usage among teens and people in their early 20s. About three years ago, Facebook piqued with the young crowd in which 98% of the 18-24 demographic had an active Facebook account. Now, that figure is around 92%. The theory is that Facebook emerged as a “safe space” for teens and twenty-somethings to interact with each other, but the past few years saw it emerge as a place for Grandma Mildred to comment on budding teen romances or school administrators to police student behavior for freewheeling comments that no adolescent would dare say at a public assembly in front of a microphone. This informal censorship leads some users to abandon Facebook in favor of a new space.

What catches my attention is that Facebook seems to be taking the Coca-Cola approach to abandonment—owning the place to which folks seek refuge to get away from you. If you don’t like Coca-Cola, you might drink Powerade. Or Dasani Water. Well, Coca-Cola owns both of those brands, too. When people leave Facebook, they go to the private chatting services of Whatsapp or the more secluded picture-sharing network of Instagram. Well, Facebook bought Whatsapp for $19 billion and Instagram for $1 billion. It made a $3 billion all-cash offer for Snapchat as well (which got turned down) but it is likely only a matter of time until Snapchat falls under the Facebook umbrella as well. Just as getting away from Coke leads you to put money in the pockets of Coca-Cola owners, getting away from Facebook seems to put money in the pockets of Facebook shareholders as well.

One of you recently e-mailed me and asked how a picture sharing network like Instagram makes money, and the answer is this: Every 4th, 5th, 6th, 7th, or 8th picture at the beginning of the Instagram picture line-up is a native advertisement. It is an intelligent strategy that fights against ad blindness-by rearranging the sequence of the ads every time users visit the site, you are more likely to pay attention to it than if you mentally train yourself to ignore the 4th spot of every photo album.

That is something I had to figure out when running this site—I used to put the second advertisement in the middle of my articles in a static spot. The issue is that people know where it is and then train themselves to ignore it. I had to teach myself computer code so that the second advertisement would be roaming and the readers would not develop ad blindness. My aim in doing that was not to be a jerk, but to place greater value on the amount of income necessary for this site to be worth my time to run.

When I look at the Whatsapp and Instagram purchases, it reminded me that Facebook can diversify its profit engine just like any other company. Hershey’s bought Reese’s, and that greatly improved the long-term growth of the chocolate company. Procter & Gamble bought Gillette razor, and it overcame years of volume stagnation and suddenly owned a large business growing at 12%. Facebook is becoming more than just a place to share statuses and look at pictures.

Two days ago, Facebook announced that it bought The Find, which is a comparison shopping tool that automatically shuts off after you purchase the contemplated item and then comes up with complementary suggestions.

It probably won’t be implemented until the end of 2015, but here is how it is going to work: Let’s say you type in a search looking for St. Louis Cardinals baseball tickets. You browse just a little bit, don’t decide to buy anything, and then go about your day. When you log on to Facebook later, as long as you don’t flush out your cache, you will see a Facebook ad showing you St. Louis Cardinals tickets for sale with comparison prices from Ticketmaster, Stubhub, Ebay, and the St. Louis Cardinals website through Major League Baseball. You will get a comparison look of which tickets are the cheapest.

Google’s ads can already do that, but the added sophistication in Facebook’s network is that once you buy the St. Louis Cardinals tickets the advertisements will no longer appear. Then, it will retain some information to suggest complementary purchases at a later date. Around Father’s Day, it might suggest buying your dad a Yadier Molina jersey or a painting of the 1982 World Series team. If the team makes the playoffs, you might see new ticket offerings. The whole thing is targeted towards your tastes in a timely manner.

If you buy a Nordstrom coat at the start of winter, you might get suggestions for a Nordstrom tie around Christmas time or a pair of khaki shorts in spring. The point is that advertisers will pay Facebook more money to advertise towards specific demographics that are likely interested in their products. This is Facebook’s attempt to take on Google with highly customized ads. I remember getting an e-mail last year from an angry reader saying that he thought I ran a reputable site and he couldn’t understand why I was running advertisements with Victoria’s Secret models plastered on the site. I told him that those ads are run through Google’s targeted network, and any ads shown to him are based on his past browsing habits. I never heard back from him.

What is becoming clear to me is that Facebook is taking attempts to diversify away from just being one social media website. It is buying up its competitors, and has full ownership of the places that people flock in the event they move beyond Facebook. They are starting to buy up the middlemen that exist between themselves and the advertisers that pay to run ads on their media platform. I respect the business savvy in how Zuckerberg’s team is currently building the sprawling empire, even though I cannot predict its future nor can I get behind stocks with P/E ratios of 73.