Why Google Deserves Its Valuation and Facebook Doesn't

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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I know what Facebook is about: Making a mockery of money.

When the social network bought WhatsApp for $19 billion, listicles of how else it could have spent that money proliferated: GQ suggested 82.5 million bottles of Johnnie Walker Blue, CNN the UN's annual aid budget (in the latter case, Facebook would have had $6 billion left over).

Now that Mark Zuckerberg's company is worth more than $200 billion -- $201.55 billion at the time of this writing -- it's time for people to amuse themselves with that shallow math again. My favorite comparison -- now making the rounds on Twitter -- is with Russian President Vladimir Putin's crown jewels, oil producer Rosneft, natural gas monopoly Gazprom and state-owned lender Sberbank. Their combined market cap at the time of this writing was $202.3 billion, meaning that Russia's vaunted energy wealth plus its financial power -- Sberbank is by far the largest bank in the nation -- is worth about as much as a company with 7000 employees that only made $7.8 billion in sales last year, compared with Gazprom's $165 billion.

The comparison is pointless for a number of reasons, including the political factor and the old economy vs. new economy divide, but it's inspiring: 10 years of bold innovation using little except your brainpower and some silicon chips can make you wealthier than building infrastructure for decades and having hundreds of thousands of people run it. It's a fairy tale with a moral almost everyone -- with the possible exception of Putin -- likes.

What worries me, though, is Facebook's inexplicable advantage over its new economy peers. Google's market cap is only twice that of the social network, and its revenue approached $60 billion last year. Facebook has a price to earnings ratio of 85 compared with Google's 30 and a price to free cash flow ratio of 61 compared to Google's 37.

It's reasonable to compare the companies because both have advertising-based business models and both can reasonably serve as proxies for the mobile economy if you're hesitant to risk betting on hardware companies like Apple or Samsung. Accordingto research company App Annie, Facebook and Google have four apps each in the U.S. App Store's Top 30.

The two main arguments in favor of Facebook are that its earnings are growing twice as fast as Google's and that its gross margin -- 80 percent -- is much higher than Google's 57 percent. Besides, Facebook's investments appear to be more focused: While it pays a lot of money for apps that don't bring in much revenue, the goal is always to increase the share of time people spend with Facebook-owned products. Google, by contrast, is branching out into drones, robots, driverless cars and other sci-fi ventures without immediate commercial prospects.

All that might justify Facebook's aggressive valuation if it weren't for the fundamental difference between the two companies' core propositions. Google offers an essential service: search. Its offering in that area is so comprehensive and so dominant -- Google's market share in search is more than 88 percent -- that, if it suddenly disappeared, most people wouldn't know what to do. Facebook has several services: messengers, a photo sharing service and a blogging platform, but none of them is as essential as Google's. Facebook is the clear leader in social media now, unless one counts Google's YouTube, but if it went down today, people would quickly switch to other social networks and messengers.

Social networks are supposed to be sticky because people hang out where most of their friends are. Half of Facebook's 1.2 billion active users have fewer than 200 friends each, and the average is 338, according to Pew Research. Such a small number is easy to recreate on a different network.

I left a social platform behind once -- LiveJournal in 2011 -- and am now in the process of leaving Facebook. The annoying self-launching videos that Facebook is so proud about were the last drop for me. Even with more than 4400 friends and 99,000 followers -- many of them fake accounts, as it often happens on Facebook -- switching to Twitter is not a traumatic experience: Most of my friends are already there.

It's hard to say whether Facebook's user base is growing, stagnating or eroding in its mature markets. The public gets glowing reports about the company's growth in Africa, but not about dynamics in the U.S. or Europe. After the U.K. daily The Guardian reported in April that U.K. and US user numbers were on the wane, SocialBakers, the market research company whose data were cited in the story, stopped reporting such numbers to non-subscribers, explaining that they had been rough estimates and the journalists had got it wrong.

Google, on the other hand, has reliable stats for its basic service. Last year, the number of searches it handled increased 15 percent to 2.16 trillion.

The moral of Facebook's tale is as much about risks swept under the rug and inflated expectations as it is about rewards to pure creativity. A deflation of the bubble, even a partial one, would make a nice cautionary tale.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net