By Jake Mann and Meena Krishnamsetty
Facebook Inc. FB +0.63% has been criticized quite heavily since its IPO debacle earlier this year. Whether it is calls for the company to hire another head honcho to replace Mark Zuckerberg, or claims that it isn’t doing enough to protect the privacy of its users , it seems like every armchair analyst has something to say about the social network.
From an investment standpoint, most of bear concerns over buying into shares of Facebook have to do with revenue diversification, or lack thereof.
Current estimates place around 85% of the company’s revenue as dependent on advertising, and we all know how certain their foothold in that arena looks right now .
While competitors like LinkedIn Corp. LNKD +0.34% andGoogle Inc. GOOG +0.84% have taken steps to limit their social networks’ dependence on third-party ads, it seems like the best Facebook can do is ponder how they can improve the functionality of their mobile app.
What if we told you there is another way for the social network to make millions, even billions of dollars? Even more so, what if this technology had been laying under investors’ noses since 2008?
Ladies and gentleman, we’d like you to put your hands together for…(drum roll please)…Facebook Connect.
Facebook Connect is the oft-used program that lets users sign into their favorite third-party websites with their Facebook login, and is on every domain name under the sun, from e-analytics site Alexa, to real estate information site Zillow.
Released four years ago to relatively little fanfare, Facebook Connect is the bastard son of the company’s API and platform programs, which were introduced in 2006 and 2007, respectively.
On the official Facebook blog, the company states that Connect allows its users “to take their identity and friends with them around the Web, while being able to trust that their information is always up-to-date and always protected by their privacy settings.”
Besides being a convenience for web surfers, Facebook Connect is also boon to websites that integrate the platform into their login systems. Take music streaming database Spotify, which is a Napster-ish version ofPandora , as an example of how Connect integration can be taken to the nth degree. Since making it a requirement for users to login to its system through Facebook last September, Spotify has added roughly 5 million users — a total representative of 25% of its user base.
Other third-party sites implement a less extensive version of Connect, though its biggest benefit is that it is free. In its first year of operation, Facebook reported that roughly 80,000 sites had integrated with the service; this total had grown to 2 million by the end of 2010.
In the 20-plus months since, Zuckerberg and Co. have estimated that 10,000 sites a day are syncing their login systems with Connect. Doing a few back of the envelope calculations, this means that Facebook Connect must have upward of 8 million partner sites currently, with this total expected to reach 12 million by the end of next year.
Though there are no perfect comparisons for Facebook Connect, we can make a few indirect conclusions about the potential of the service, if Facebook decided to start charging third-party sites.
LinkedIn Premium currently charges subscribers $24.99 a month; it is notable that this premium pricing program experienced similar, but lesser growth than what is expected of Facebook Connect.
As of its most recent annual report, LinkedIn reported having close to 25 million premium subscribers. LinkedIn Premium has been in existence since 2003, and it is worth noting that in its seventh year (2010), the service garnered a little over 10 million subscribers. In Facebook Connect’s seventh year (2015), it is projected to have 15 million integrated sites.
Google’s social network, Google+, allows users to remain logged into its bevy of sites, ranging from Gmail to YouTube, though this integrated functionality only exists under the company’s banner, so to speak.
Likewise, Microsoft’s MSFT -0.38% new social network “So.cl” allows its users to integrate their Bing search history into its platform, but offers little else at the moment.
Thus the question remains: Is it reasonable for Facebook to charge third-party websites for the usage of its Connect service?
When answering this question, it is important to keep in mind that most sites are now developing their platforms to seamlessly integrate with Connect, making login quick, smooth, and easy for users.
If the social media company did choose to slap a price tag of, let’s say $24.99 a month, on the service, third-party sites would have little choice but to comply. Any site bold enough to resist this charge would risk losing the fraction of their user base that was signed up exclusively through Connect. In today’s rough-and-tumble e-marketplace, we’re willing to bet that this is a setback that no site, large or small, could afford.
If Facebook does choose to start charging for Connect, it would realize an additional $4.5 billion in annual revenues by the end of 2015. Considering the fact that current estimates from Wedbush Securities and eMarketer expect the company to finish 2012 with close to $5 billion in revenues, we can immediately see that any monetization of Facebook Connect would be material to the company’s bottom line.
Staying consistent with a price tag of $24.99 a month, we can then estimate that Connect monetization would add close to 50 cents to Facebook’s 2015 EPS, which current estimates place in the range of $1.50 a share. When taking this forward-looking estimate into account, Facebook’s Forward P/E drops to 26.5X, while its earnings multiple without Connect monetization rests at 35.2X.
This differential is important, because if Facebook does choose to start charging third-party websites for Connect, its valuation suddenly looks more attractive in comparison to tech peers like LinkedIn (111.8X), Google (16.0X), and Microsoft (9.2X).
While it remains to be seen if Facebook will explore the scenario discussed in this article, it is clear that investors might at least want to consider the possibility. Facebook Connect appears to be a perfect “secret weapon” for the company’s woes related to revenue diversification. After all, it is not unreasonable to expect the company to monetize a service that permeates the online environment in its entirety.
Many of the hedge fund industry’s most prominent managers are closet Facebook bulls, including Chase Coleman’s Tiger Global Management , Robert Karr , and “the Man Who Broke the Bank of England,” George Soros (see George Soros’ new stock picks ). Even financial guru Cliff Asness reported having a tiny piece of the action in his second quarter 13F filing with the SEC. For a complete list of hedge funds with Facebook, check outInsider Monkey .
Disclosure: This article is written by Jake Mann and edited by Meena Krishnamsetty. Meena has long positions in Google and Microsoft.