Why Facebook shares are twice as expensive as Google’s | Alex Pollak writes in BRW

First published BRW and Smart Investor and written by Loftus Peak’s CEO Alex Pollak.

“A few years ago, users of internet services began to realise that when an online service is free, you’re not the customer. You’re the product.” – Tim Cook, in an open letter to Apple customers.

“They do not discard anything. If they have anything they keep it. We have moved to the collection of data of the 7 billion people on our planet.” – William Binney, former senior NSA operative.

Last month I dismissed Facebook on the grounds that, as Ethan Zuckerman (inventor of the pop-up ad) put it, “targeting to intent (as Google’s search ads do) works well, while targeting to demographics, psychographics or stated interests (as Facebook does) works marginally better than not targeting at all.”

I am coming around to a more positive view, and here’s why.

Business model of the internet: surveillance

First, to be clear, the fundamental business model of the internet is surveillance. This is true whether you are Google, the NSA, or Facebook. I don’t propose to go into the legal or societal debate about whether this is good but will focus simply on the business consequences. Just like all the other investors this Thursday, when Google reports, and 12 days later when Facebook does.

Google search works incredibly well when you are about to make a decision about buying something – plumbing services, new Levi’s, a Hyundai. Outside this, the various Google products haven’t actually gained a lot of traction, moneywise. But the search business itself is so massively profitable that it gets to fund the activities of a truckload of other businesses that make nothing (driverless cars, solar power plants, etc).

The Facebook model, when it became clear how much data they had, deeply rattled the folk at Google.

The Facebook model, when it became clear how much data they had, deeply rattled the folk at Google, who thought they controlled the space completely with their search-based surveillance model, founded as it was on keeping a record of every single click made by any user who logged in. Facebook threatened them because it looked for a while like it was going to steal the next year’s advertising revenue right from underneath them, with demographic data that was way more personal and detailed than their own.

Monetisation

The risk to Google has always been that Facebook will work out how to monetise its 1.3 billion users.

The risk to Google has always been that Facebook will work out how to monetise its 1.3 billion users, and the doubling of the stock price this year says investors are getting very excited about this.

Let’s take a dive into the numbers. Google is capitalised at US$390 billion ($444 billion), while Facebook just went through the US$200 billion mark. But Google makes $20 billon at the EBITDA line, while Facebook makes just a quarter of this at US$5.5billion. So about half the value for one quarter of the earnings. Hmmm…

An easy Facebook defence would be the relative maturity of the two businesses. Google started in 1998, and Facebook started in 2004, so you could conclude that Google is further down the path than Facebook, but that Facebook will eventually get there, justifying its much higher valuation multiple.

So maybe it is worthwhile considering the two companies ten years after inception (since at this point both companies have established their business models and should have something like an revenue and earnings trajectory). Facebook will post US$12 billion revenue in 2014, up around 55 per cent. In 2008 (ten years after it started) Google posted revenue of US$21 billion, up about 31 per cent – a much bigger number than Facebook.

Facebook’s most recent quarter shows that it had 1.32 billion users, so generating revenue of $9.09/user.

Facebook’s most recent quarter shows that it had 1.32 billion users, so generating revenue of $9.09/user. Google, in 2008, had 1 billion user accounts, but it generated US$21.80 per account in revenue – so more than twice that of Facebook. Remember, this is four years ago for Google, but today for Facebook. And today’s revenue per user for Google is around US$30 – still more than three times Facebook’s.

Facebook model

The Facebook bears say that Facebook advertising is in essence an interruption for the user, just like a TV ad, only without the entertainment value. I have always likened the Facebook business model to a (blessedly) hypothetical case in which telephony is made free, as long as users agree to sit through a Coke ad in the middle of their phone conversation.

However, large stocks rarely double for no solid reason. Today, the fact that Facebook’s multiple is double that of Google’s says so much about what is happening out there in online marketing world. For while Google’s search engine provides advertisers with very specific, and effective solutions, Facebook is increasingly emerging (after a slow start) as a platform to watch, stock-price wise.

No one platform controls all the inventory – not Google, or TV or Facebook.

No one platform controls all the inventory – not Google, or TV or Facebook. Ask any half decent online advertiser, and they will tell you that Facebook is a product that they increasingly can’t ignore or even do without.

Newfound ability

The core of the Facebook story right now is its newfound ability to track users across non-Facebook platforms into other apps and (especially) mobile devices and serve advertising to them as if they were still on Facebook. This allows the company to earn money by leveraging its personal data trove for targeting without cluttering its own service with any more ads. It lets advertisers get in front of more people in a certain demographic more frequently than if they would on Facebook itself, which would become excessively cluttered with ads, and so mar the user experience. The ads don’t get in the way of the Facebook user while he or she is on Facebook (remember, for social reasons) but are served from non-Facebook platforms, using the Facebook demographic data. Neat, powerful and monetisable. And I can now see a very good reason for why Facebook has doubled this year. Expect more of this when Facebook reports, but it is serious stuff.

And privacy? Both models rely on the deep analytics that are available as a result of the surveillance that is the fundamental business model of the internet. So its not in the equation – yet. The real threat to the companies on the net, in this writer’s view, will come when people generally take the view that their privacy is worth more than the benefit they get from knowing where they are going or who is canoodling with whom. Apple’s Tim Cook, in his letter to customers, seems to be flagging this as a new battleground – it’s all over the rhetoric of the Apple Pay platform, for example.

If there is a market-based solution to the privacy question, expect to see some very rapid value transfer as the existing businesses defend against these disruptive newcomers.