May 22, 2012

Hey, Facebook. Here’s 3 Reasons Why You’re No Google

Important differences between the two companies make Google-like returns tough to achieve

Facebook CEO Mark Zuckerberg. (Photo: AP) Facebook CEO Mark Zuckerberg. (Photo: AP)

Facebook  shares tumbled 11% to $34.03 on Monday, and aren't faring much better on Tuesday, as questions over what happened and who’s to blame (NASDAQ?) continue.  

Jack Hough, writing on SmartMoney’s Real-Time Advice blog, notes, “Shareholders who had bought the stock for a quick flip must now consider whether to defy all those Facebook skeptics and hold it longer. That has worked out beautifully for anyone who has held Google (GOOG) stock since its 2004 debut. It has multiplied sixfold in price.”

Like Facebook (FB), Google is a purely online business with a dominant market share, Hough adds. It makes most of its money from advertising and turns a high percentage of each revenue dollar into operating profits. Its stock was also initially panned by many as too expensive.

But Hough believes Facebook will have serious trouble generating Google-like returns for investors, noting the “important differences between the two companies.” He helpfully lists three:

1. Facebook is twice as expensive as Google was following its own stock market debut.

“When Google came to market in August 2004, it had booked $2.3 billion in revenues over the prior four quarters,” Hough writes. “The stock ended its first day of trading at a price that valued Google at $27 billion. Those numbers make for a price-to-revenues ratio of about 12. Facebook ended Monday with a value of $93 billion, and it has brought in $4 billion in revenues over the past four quarters. That’s a price-to-revenues ratio of 23.”

2. Google has already plucked the low-hanging fruit.

Back in 2004, newspapers and magazines together captured 43.8% of advertising spending, versus just 3.7% for websites, Hough explains, citing Zenith Optimedia.

“That gap has narrowed. This year, 27.3% of advertising dollars are expected to go to newspapers and magazines, and 18.2% is expected to go to websites … In other words, Google thrived in part by capturing business from vulnerable print publications, but the weakest of these have closed, and others have built thriving websites. Facebook will have to compete for ad dollars with a stronger core of print companies and their websites, and more important, with the likes of Google.”

3. The world only needs so much advertising.

“Suppose Facebook grows much more skilled in turning its traffic into advertising dollars. Couldn’t it then multiply its revenues 17 times over the next eight years, the way Google has over the past eight?” Hough asks. “After all, the company’s active user base consists of 13% of humanity.”

There’s a problem with that thinking, he concludes.

“Google’s rise didn’t prevent print media companies from selling ads. Rather, it cratered the prices for such ads. For example, Google’s AdSense allowed just about any website owner to sell advertising by banding together with a massive jumble of other websites. The result was a flood of new pages available for ads, creating more supply than demand. For a company of Facebook’s size, that presents a dilemma. If it doesn’t learn how to effectively sell ads against its massive traffic, its revenues won’t grow quickly, but if it does learn, the result may be a glut of ad-space supply and a drop in prices, restraining revenue growth just the same.” 

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Read How to Buy Facebook Without All the Risk at AdvisorOne.

Check out Facebook Frenzy Is About Separating Fools From Their Money: News Analysis at AdvisorOne.

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