Facebook’s facing limits

by Scott Denne

Facebook’s second-quarter revenue miss lays bare a problem that goes well beyond its momentary struggles with new European privacy regulations or the resentment it faces for sharing user data with Cambridge Analytica and its profiting from misinformation. The social media giant’s valuation is bumping into the limits of its addressable market – a market that its main rival looks more likely to win.

Facebook shed about 18% of its market cap after delivering 42% topline growth – enviable for almost any other company, although below what the street expected. Exacerbating the decline, it told investors to expect high-single-digit deceleration of its growth rate in each of the next two quarters. That’s a stark contrast to Google, its rival for dominance of the advertising market, which reported accelerating ad revenue earlier this week.

By most estimates, the entire global ad market (digital and offline) sits at roughly $550-600bn and by that measure Facebook, whose sales come almost entirely from ads, commands nearly 10% of it. While it’s still growing, its market cap, which was about $620bn before earnings, implied that much of that market would shortly come under its control. Slowing growth tamps down those expectations, as does the larger share that Google’s taking – its yearly growth jumped four percentage points last quarter to 23%.

An ambitious set of acquisitions has given Google’s ad business – already twice the size of Facebook’s – a stronger trajectory. While Facebook’s major purchases have mostly been extensions of its core social media business, Google (now Alphabet) has bought a diverse set of products both inside and outside of advertising. Outside of advertising and media, it shelled out billions to buy, among others, a thermostat company (Nest), a phone maker (Motorola) and a mapping app (Waze). Although a bit of a spendthrift, Google generates 14% of revenue outside of advertising.

Even within advertising, Google printed big deals to move beyond search. For example, it paid $1.65bn for YouTube in 2006, when such an investment in online video seemed laughable, although that transaction has now given Google a foxhole to launch a digital assault on the TV market. According to 451 Research’s Voice of the Connected User Landscape, 58% of consumers watch video content on YouTube, more than any other free streaming service and double the number that stream from TV networks’ own websites.

By comparison, Facebook hasn’t made a large acquisition outside of social media since reaching for Oculus VR more than four years ago. In fact, it hasn’t made any $1bn deals since it bought that virtual reality headset vendor. This year, it has only purchased three startups, including workplace messaging service Redkix, which it announced Thursday. If Facebook plans to regain the value it lost with its latest earnings announcement, it’s going to have to ink some riskier acquisitions that increase its addressable market, or at least take it into new corners of advertising. A seed-funded company with yet another new spin on email isn’t going to be enough.

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M&A ramp-up for Facebook?

-Contact Thomas Rasmussen

Facebook’s rumored offer for micro-blogging site Twitter had the Web all atwitter recently. The $500m bid was reportedly rejected because it came in the form of a stock swap, with Facebook inflated to the infamous $15bn valuation that the social network got in Microsoft’s investment a year ago. Judging from our talks with insiders throughout the year, everyone knows this is a ludicrous valuation. Still, we wonder why some people – including big media – are still bandying this around, and more to the point, why Facebook thought Twitter would buy into the valuation. (More realistically, bringing the valuation down to earth, the offer amounts to $100-130m.) Nevertheless, the rumored run at Twitter confirms our speculation in June that Facebook, which has hardly ever dabbled in M&A, is gearing up to go on a substantive shopping spree. If that’s the case, it could do a whole lot worse than roping in Loopt.

When we first reported on this possibility, we had heard that initial talks were under way. However, the less-than-stellar adoption of the overhyped location-based services (LBS) applications probably put a damper on the enthusiasm. Nonetheless, recent developments have made LBS an attractive area again: Android devices have hit the market, the iPhone continues to sell well and Nokia is rolling out its own sleek new smartphone. Granted, the degree to which people are interested in having friends and family track their every move is debatable. But for Facebook and other social networks, which essentially base their entire business models on our instinct to pry into each other’s business, adding Loopt’s service to its currently static desktop and mobile offering is a no-brainer. And if Facebook was willing to hand over north of $100m to acquire Twitter, spending the same amount on Loopt, which is roughly where we pencil out its valuation, would make a lot more sense.

Social network M&A, 2006-2008

Period Number of deals Total known deal value
2008 YTD 32 $98.3m
2007 12 $149.7m
2006 8 $31.1m

Source: The 451 M&A KnowledgeBase