Originally published by Cuffelinks
Facebook (NASDAQ:FB) is a fundamentally strong business. It has a sustainable competitive advantage, the ability to grow organically and the capacity to grow earnings over the long term. These are the things we all look for in companies we invest in, but what’s interesting and different about Facebook is the business itself. It has morphed from a channel to keep in touch with friends to a sophisticated social media platform. It has disrupted not only the way we communicate and consume media, but it continues to play a more integral role in our lives.
Facebook reports that the average user spends 50 minutes a day on Facebook, Instagram and its Messenger platforms. Considering the average person spends nine hours sleeping, then about an hour out of the remaining 15 is a lot. And that’s the average. At least 1.3 billion people use Facebook for more than 50 minutes a day and 15% of users look at it more than 50 times a day.
Much of that time may be spent corresponding with friends, but some is also spent consuming media, making Facebook a powerful force to be reckoned with. Facebook is changing and disrupting the way we consume media, and more importantly, what we consume.
Facebook’s power lies in the curation of media
Facebook has not replaced traditional forms of communication, but in a way unheard of in the past, it packages other forms of media, TV, print and radio in an accessible and digestible form. But even that isn’t where Facebook’s real power lies. Far more significant is the fact that Facebook curates what we consume.
Depending on what we have read, watched or listened to in the past, Facebook can serve up the stories it thinks we are most interested in. Every click and every view is measured and analysed to refine what will be sent next time. As artificial intelligence becomes more sophisticated, Facebook’s ability to learn and deliver according to individual tastes will grow exponentially. And all of this content can come from anywhere within its enormous network, not just your friends or even your friends’ friends. It’s a fundamental shift in the way we receive what we see and hear, and the implications are profound.
Facebook may be more in control of what we see, watch and hear than any single media company or government in history, yet it is largely unregulated. There are no media laws to exert control over what is presented to users, and it’s a fine line between being a platform and being a publisher. There’s a blurring of lines, and there’s no going back.
Does disruption translate into profits?
Just because Facebook has disrupted the way we interact and consume media, does it follow that it is a good investment? Will it continue to increase revenues sustainably and produce returns for investors? As more people and businesses use platforms like Facebook to communicate via messages, photos and videos, the network effect means that the platform’s value proposition will increase. Given that engagement, are increased revenues and profits a sure thing?
There’s no such thing as a sure thing when it comes to investing, but in our view, Facebook has the strong fundamentals needed to sustainably increase revenues over the long term.
While engagement may not in itself produce revenue, it correlates strongly with advertising effectiveness, which does generate income. That’s why 50 minutes a day is significant. When combined with Facebook’s ability to reach 26.6% of the global population and target groups of people with certain characteristics, it translates into a strong market position and the ability to charge for advertising.
The more time we spend on Facebook, the larger the number of impressions (items people have looked at) Facebook can sell to advertisers, and the more Facebook knows about you. Which in turn allows advertisers to target you.
At the same time, it’s surprising how few companies currently advertise with Facebook, given its wide reach and power. Around 70 million businesses have pages on Facebook yet only five million advertise, and spend a relatively small average of US$7,000.
However, the global advertising market is estimated at US$550 billion and growing at approximately 4% per annum. Of this, US$205 billion is spent on the internet, yet only US$34 billion of that is spent on Facebook. Facebook currently controls only around 7% of the global advertising market.
In our view, Facebook’s control of global advertising is set to rise. Even if we don’t consume more media in the future, we will certainly consume more of it online. And given that the internet, including Facebook, offers by far the best targeting techniques, the growth in the internet’s share of advertising will also accelerate.
The bottom line is that Facebook’s advertising revenue is likely to rise, and combined with a small increase in profit margin, it paints a picture of a strong and growing business.
Software developers have worked with Facebook to allow businesses and individuals to manage multiple Facebook pages to stay close to local communities and also promote goods and services consistently across the country. Statistics which Facebook can glean from analysis of users can be crucial for businesses seeking to understand and target their ideal customer.
What does it all mean?
Facebook is the ultimate disruptor. It has changed forever the way we interact with each other and businesses. But more importantly, for long-term, fundamentals-based investors, Facebook’s strong business model, competitive advantage and ability to grow revenues organically and sustainably make it an excellent investment.
Tim Samway is Managing Director of Hyperion Asset Management.