The best way to think of Facebook’s stock is as the sum of two businesses: the existing display ad businesses, and a probability-weighted option on a new line of business. This is how Wall Street views it. For example, here is a section of a recent Goldman Sachs analyst report on Facebook:
Optionality not in the model: further potential upside
While not in our model, as [Facebook] has not publicly expressed pursuit of these areas, we believe there are three obvious opportunities that the company could leverage its platform to capitalize on:
– Developing an external ad network
– Monetizing paid search
– Entering China
Of the three options, search is clearly the most interesting. An external ad network is inevitable. Google proved this model with Adsense. With an already huge base of advertisers bidding on CPCs, it is impossible for most other ad networks to compete on publisher payouts. But Facebook’s traffic is so great now that an external ad network might increase their revenues by 2x or so. The same goes for entering China. They might get another half a billion users who monetize at lower ad rates than US users. Neither move would put them in Google’s revenue range. They need a better business model for that. The only (known) models that deliver RPMs high enough to compete with Google are search, payments, and e-commerce.
At TechCrunch Disrupt last week, Mark Zuckerberg talked about possibly entering the search business. Investors had been concerned that maybe Zuckerberg really meant what he said in his IPO letter – that he just didn’t care that much about making money. By expressing an interest in search, Zuckerberg signaled that he understood Facebook’s immensely valuable embedded option and was thinking about ways to exercise it.