The $7B Incremental Revenue Potential
At my company, CoRise, we do a lot of postulating, like “What if…?” Yesterday, I read a really poignant piece yesterday by Henry Blodget on the possibilities of search revenue for Facebook. It’s a thought-provoking piece and I recommend reading it here. This piece really underscores the “optionality” that has made me positive on Facebook before. Recently, I spent a good deal of time reaching out to industry pundits to get their opinions on the prospects for Facebook. We discussed many topics, possibilities, and the challenges for Facebook to overcome. The one resounding theme that most agreed with was: In the near term Facebook will have to overcome hurdles (ie. the transition to mobile), but with the audience size they reach and the talent at the company, the company has a tremendous long term opportunity that they should be able to execute against. Of course, execution will be everything.
The challenge in investing is trying to look passed the current picture to predict what could be. For example, “how big could revenues become?”, or “how large could margins be”? or “what competitive moats does the company have around its businesses?” These are all important questions that investors ask, but usually the most difficult one is “how big could revenues become?”. This is so hard to estimate because it requires thinking about what FUTURE businesses the company might enter, not merely extrapolating the current businesses. For example, before 2007, did investors think Apple would have a phone, let alone a tablet? And unfortunately, investors need to think about the potential opportunities BEFORE they announced – otherwise it’s too late.
This type of thinking has led me to ponder what various business extensions / partnerships / new revenue lines could the company be considering. Facebook is filled with smart people and they are clearly thinking about these issues – it would be ignorant to assume they are not. So I wondered, “If I were working at Facebook in the C-suite, Corporate Development or Business Development, what would I be trying to do?” The following are some areas that I think would make sense for Facebook to be looking into – each one has a few things in common:
1) it does not harm the user experience (and hopefully augments it),
2) it provides a greater utility for a partner / advertiser,
3) it is a large opportunity, because of the large audience reach of Facebook,
When one sums up the magnitude of these opportunities, it can be staggering – the total can be in the many billions of revenues (FB is expected to only have $5b in revenues this yr). Further, most of these opportunities have huge margins, falling directly to the bottom line.
Potential Opportunities for Facebook
1) Search – $3B Revenue Opportunity
What if Facebook focused on search? According to AdWeek, Disney and Zynga are already testing the new beta service FB is rolling out. Henry Blodget does a great job covering this in the article I cited above. Based on the ~500m users that live on Facebook and the ~1.6b searches done each month, he calculates that Facebook could generate ~$1b of incremental revenue immediately. Further, he calculates that with some tweaks, it could balloon towards $3b of revenues per year. The best part, it would be almost 100% pure margin (just like it is for AOL today).
2) Commerce – $1B Revenue Opportunity
What if Facebook made a real push into commerce? I’m not saying that Facebook should start taking on inventory, but what if Facebook cut a deal with Amazon for example and opened up “Facebook Stores” where inventory from Amazon and its affiliates could be viewed / bought. Amazon would love to tap into Facebook’s ~500m monthly visitors. Doing some simple math, if only 2% of FB users shop at the store per month and spend an average of $50, that’s $6b on gross revenue per year. Assuming Facebook gets the typical 15% commission, that almost $1b / per year in pure margin revenues for Facebook (20% boost to current revs)! And that ONLY assumes a 2% shopping rate of users.
3) Payments – $1B Revenue Opportunity
What if Facebook signed a deal with a credit card company like American Express to offer a discount on Payments for developers? Facebook could incentivize its developers to prefer Amex, with Amex giving a discount to FB developers. It would be a win for everyone: Amex would get access to FB’s users & developers; developers could offer lower prices to their gamers to augment usage; and FB would drive more game development and users engagement. Payments is still small for Facebook (~$800m runrate), but it’s growing >60% and this could add an accelerant. Further, FB could gain access to AMEX’s legion of small businesses, expanding its reach and engagement. So if the discount on apps encouraged users to sign up for an Amex card (for example), FB could receive a customer referral fee. If just 2% of the user base signs up, at a typical $100 customer acquisition fee, FB could have another $1b business. There are many ways payments for Facebook could blossom, and this is merely exemplary.
4) Distribution (Open Graph) – $1B Revenue Opportunity
- App Center – What if Facebook charged developers for app downloads? Facebook is a massive platform that can provide distribution for almost any consumer-facing product. In June, Facebook just started rolling out its new AppCenter (it’s primary distribution arm). This is where free apps can be downloaded and played by users. Facebook does not monetize this directly yet, but it could by taking a percent of in app advertising, charging per download, or by letting developers pay to appear higher in the search for apps. So if 10% of FB’s 500m users download 10 apps per year and FB charge the developer $1 per app, that would generate $500m (10% bump on revenues). The developer is happy because they have a new customer and FB benefits for its distribution. But what if FB also offered incremental ways for developers to stand out from the sea of apps? Would the developers be willing to highlight their app vs the others (ie think how eBay allows for sellers to “bold” or “color” their listings for a fee). This could add significantly to this bucket of revenues. Of course advertising opportunities only augment this possibility.
- Subscription Services – What if Facebook charged subscription services for new users it signs up? Earlier this month, Facebook rolled out Subscription services in the app center – initial customers are Zynga and Kixeye. Techcrunch did a great piece, on how Facebook could earn millions if it collects the typical 30% surcharge for its distribution of Spotify. What if FB can get 5% of its 500m users to start a monthly subscription to Netflix, Spotify, Hulu, satellite radio or other digital services? Assuming an $8/mo subscription price and maybe only a 20% cut of the revenues, FB could generate $500m in annual revenue. Now what if FB applied that to more traditional media, like magazines, newspapers, cable’s “TV anywhere”? This could become a multi billion dollar business itself. Reed Hastings, CEO of Netflix, is on FB’s board and recently bought $1m in stock – maybe he understands this?
5) Apple – $1B Revenue Opportunity
What if Facebook and Apple formed a tighter alliance? Apple is in need of a social strategy, with its Ping product not taking off and with reported negotiations between Twitter hitting a snag. Why does Apple need Facebook? Apple sells hardware – it’s a one time sale and then the customer is gone. Apple is looking for a network effect, aside from the integration of its various devices. It does not provide a compelling reason for its customers to come back each day and engage. What would that be worth to Apple on product reinforcement basis alone? What about an advertising angle for Apple (especially on mobile with its ad service rumored to not be doing as well as Apple would like). It could benefit the Apple app store / iTunes as well. So what if Apple integrated FB more tightly and the network effect of social connections created a small lift to sales (ie there was a benefit to users being on similar hardware, access to iTunes, or being mobile)? Apple sold ~50m units last quarter (ex iPod) or 200m units per year just straight lining. If they had a 5% lift to sales of these units (10m units) and we assume a $700 mixed ASP, that would generate an incremental $7b to Apple. If FB takes a 15% commission (referral fee), that could drive another ~$1b in annual revenue. This ignores any lift from advertising, where Apple could hone its mobile ads based on social information. Now, what if FB did this with other hardware vendors as well?
There are many other businesses that I think are also ripe for FB to provide a better service to its users while simultaneously monetizing. However, I think the sketched out above ~$7b revenue opportunity paints the larger thesis: There is a tremendous opportunity in front of Facebook, based on its large, active user base. What if the company executes on this while continuing to augment the consumer utility? How would the company’s financials could look vs today? The risk of course is that the company doesn’t execute and collapses under its own weight. The company’s valuation has come down significantly to ~16x ‘12 EBITDA and 9x ’12 revenues, according to analyst estimates. However, without new businesses, that is not cheap given the declining revenue growth.
To be long here on Facebook, I think an investor must ask themselves, “What if….?”
Disclosure: I own FB shares. My firm has not done any work with Facebook.