December 8, 2010

dotCommerce: Social networks

Equity Research

Social networks vie with search engines to drive e-commerce

Global e-commerce may triple to $3 trillion by 2020E
We expect global e-commerce activity to grow from about $1 trillion in 2010 to about $3 trillion, or 14% of retail spending, in 2020. While ecommerce companies themselves (such as Amazon) and search engines (such as Google and Baidu) should benefit, we also expect social networks (such as Facebook) to tap into the resulting advertising opportunity.
AMERICAS: RETAIL: RETAILERS DREAMING OF A DOTCHRISTMAS DECEMBER 6
Americas: Technology: Internet: Takeaways from our e-commerce holiday trends conference call November 30 Americas: Retail: GS/ICSC Annual Survey suggests accelerating sales into Holiday November 22 Amazon (Buy): Amazon expands presence in baby-care and consumer products November 08

Social networks compete with search engines as traffic drivers

We believe that search engines direct consumers to commerce via the wisdom of crowds; social networks via the wisdom of friends; and ecommerce sites via the wisdom of prior shoppers. We assume search engines and social networks will increasingly compete for consumers attention, and thus for advertiser budgets.
Amazon (Buy): Probably a 30-something not 20-something revenue grower in 2011 October 22 Google (Buy): Deeper into display October 18

VALUATION AND KEY RISKS

Our 6-month, DCF-based target price for Google is $700, equivalent to 21X our 2011E EPS and 18X our 2012E EPS. Key risks include competition from Microsoft and Facebook.

Facebook to take share of contextual and performance advertising

We do not expect Facebook, or Facebook-plus-Bing, to develop a more popular search engine than Google. However, we believe Facebook may seize substantial market share from Google in contextual advertising, which is 15% of Googles gross revenue, given Facebooks user profile knowledge. Facebook may also pick up limited share from search engines in performance advertising, given that Facebook is now 4%-9% of upstream traffic to major e-commerce sites (up from 2%-4% in 2009).
James Mitchell, CFA
(212) 357-1849 james.mitchell@gs.com Goldman Sachs & Co.

Ingrid Chung
(212) 902-2360 ingrid.chung@gs.com Goldman Sachs & Co.

Adrianne Shapira

We estimate Facebook will generate about $15 bn revenue in 2015

We forecast Facebook growing revenue from over $1 billion in 2010 to about $15 billion in 2015, making it more than twice the size of Yahoo! today, and around half the size of Google today. We estimate that about $3 billion of Facebooks revenue could be indirectly at the expense of Google, reducing Googles revenue by 5% versus what it might otherwise achieve.

(212) 357-4174 adrianne.shapira@gs.com Goldman Sachs & Co.

Jordan Monahan
(212) 902-1879 jordan.monahan@gs.com Goldman Sachs & Co.

Fred Krom
(212) 902-8618 fred.krom@gs.com Goldman Sachs & Co.

Social networks moderately important traffic drivers in Asia

Pre-Facebook social networks (Tencent, Mixi, Cyworld) drive about 4% of traffic to e-commerce sites in Asia, but focus on user micropayments rather than e-commerce or advertising for revenue generation.

Scott Kaufman-Ross
(212) 934-4206 scott.kaufman-ross@gs.com Goldman Sachs & Co.

The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification, see the end of the text. Other important disclosures follow the Reg AC certification, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.

The Goldman Sachs Group, Inc.

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Contents
dotCommerce a $3 trillion global opportunity The wisdom of crowds, friends, and the interested Wisdom at work, and differing wisdoms in conflict We expect Facebook may challenge Google in two of the three ways that Google currently dominates the Web Existing Facebook revenue streams O&O branded revenue and micropayments Financial implications for Facebook, and for Google What could Google do to avert the Facebook threat? 2 3 5 6 14 15 18

dotCommerce a $3 trillion global opportunity

We estimate that global retail spending is about $20 trillion per year. Based on the experiences of individual categories (such as books, which are about 25% sold online in developed countries prior to the arrival of e-books) and individual countries (such as Korea, where about 15% of retail spending is online in 2010), we believe that about 15% of retail spending will have moved online in the next 5-10 years, for an approximate $3 trillion revenue opportunity (see Exhibit 1). Exhibit 1: We see global e-commerce sales surpassing $3 trillion by 2020
$ millions and % of total
14% 13%

WW e-commerce ($ mn)

10%

3,000,000
9% 7% 8%

10%

11%

3,500,000

12%

13%

4,000,000

16% 14% 12% 10% 8% 6% 4% 2% 0%

Penetration of total

2,500,000
5% 6% 2010E

2,000,000 1,500,000 1,000,000 500,000 -

2011E

2012E

2013E

2014E

2015E

2016E

2017E

2018E

2019E

Source: Company data, Department of Commerce, Erwin, IDC, US Census, Goldman Sachs Research estimates.

While we see retailers, e-tailers and marketplaces as the largest and most direct beneficiaries of e-commerce activity, they operate in a fragmented environment we forecast the top three e-tailers and marketplaces possessing only 14% share of an approximately $1 trillion e-commerce market in 2011. By contrast, we forecast a $40 bn paid search market in 2011, but estimate that the top three search engines will possess 89% market share. Furthermore, whereas e-tailer operating margins are typically in the high single digits, advertising media operating margins both offline and online are typically in the 20%-40% range.

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2020E

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The wisdom of crowds, friends, and the interested

We see at least three Internet services that influence where a consumer shops online:

The wisdom of crowds search engines

Consumers may simply decide that wherever other people shop, they should do so too, even if the other people are unknown to them. In the offline world, this is common behavior at venues such as restaurants. Search engines such as Google are the purest online expressions of this wisdom, as they look at where other people have clicked and use that information, along with other tools, to rank responses to queries. Advantages of search engines for determining where to shop include their ability to capture the broadest range of data points. Disadvantages of search engines include the fact that other shoppers may differ from the current shopper in terms of nationality or income or interests.

Also, search engines have historically performed poorly at distinguishing good publicity from bad publicity, as they give more weight to sites with many inbound links, even if those links are critical. The New York Times ran a story about an eyeglasses e-tailer, DecorMyEyes.com, whose owner boasted online that customer complaints improved his Google ranking and thus his sales. (See A Bully Finds a Pulpit on the Web, November 26, 2010.) Google and some other observers attributed DecorMyEyes.coms success to other factors, such as Search Engine Optimization tools. For local results, Google provides a star-ranking system next to the listing that could alleviate this issue (see Exhibit 2), but we believe sites that attract heavy commentary, positive or negative, may still appear high up in search engine listings. Google has recently addressed the above example via an adjustment to its algorithmic engine, but admits the solution may be imperfect.1

Being bad to your customers is bad for business on Googles official blog at http://googleblog.blogspot.com/2010/12/being-bad-to-your-customers-is-bad-for.html.
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Exhibit 2: Google now incorporates local store listings and reviews within search results

Source: Google.

We believe that search engines are particularly useful at facilitating online shopping for: Consumers deciding to purchase a commoditized product. Consumers who are not sure which websites might stock a particular product, such as an unbranded article of clothing.

The wisdom of ones friends social networks

Testimonials from friends, and the company of friends, often determine where consumers shop and what they purchase. Social networks such as Facebook are developing tools that facilitate purchase decisions based on friends recommendations. Advantages of social networks include the trust people place in friends recommendations because they know friends preferences. Disadvantages of social networks include the fact that most people have a limited number of friends (Facebooks average user has 130 friends) whose opinions they respect, of whom only a limited subset may be relevant for any given purchase.

Social networks could theoretically work around the limited-number-of-friends problem by enabling recommendations from ones friends-of-friends as well as ones friends, but we believe such behavior largely dissipates the benefits of trust, and therefore defeats the purpose of using a social network versus a search engine. We assume that social networks are particularly useful at facilitating online shopping for: Consumers going through a universal lifestyle change, such as new mothers looking to purchase diapers for the first time, or young adults leaving college to start work. Consumers looking to buy a product that fits in with products owned by friends, such as a teenager buying skincare products, or an adult choosing a mobile phone carrier on the basis of friends belonging to the same network.

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The wisdom of the interested recommendation engines

The views of other consumers who are not personally known to the shopper but who have purchased similar items can be particularly helpful. These views are not usually available in the offline world, except through specialist publications such as the Zagat Survey for restaurants. E-commerce sites such as Amazon make recommendations to consumers based on what other consumers who purchased the same products subsequently bought too, supplemented by purchaser reviews. Advantages of recommendation engines include: The ability to recommend products based on actual interest areas rather than what ones friends or the world at large like. The capacity to highlight products that a consumer did not know were available. The fact that reviewers are typically knowledgeable about the subject matter.

Disadvantages of recommendation engines include dependence on a relatively limited number of reviewers, often with vociferous feelings on certain topics. For example, several PC games that achieved high scores in Metacritic, a game review site, received low scores on Amazons ranking system due to reviewers objecting to the games antipiracy features.

We believe that e-commerce recommendation engines are particularly useful at facilitating online shopping for: Consumers interested in a niche media topic, such as books on jazz or movies about warfare. Consumers who own a product that benefits from purchasing ancillary products, such as a swimming pool and swimming pool cleaning equipment.

Wisdom at work, and differing wisdoms in conflict

Search engines and e-commerce sites have happily coexisted
Many consumers rely on search engines and recommendation engines together to navigate online purchasing.

Signs of tension between search engines and social networks

We believe conflicts between the different finding methods will grow over time given: The emergence of Facebook is propelling social networks to a more central ecommerce role, and we believe consumers will generally use a search engine or a social network, but not both together, when deciding where and what to purchase. Search engines are moving downstream into roles traditionally fulfilled by ecommerce companies, such as aggregating air ticketing data or selling discount coupons. E-commerce sites have developed tools to retain consumers within their sites. For example, a consumer who wants to buy books may always go straight to Amazon because they have paid for a Prime subscription, or a consumer who wants to buy vacations may always go straight to Expedia because they have joined the companys loyalty program.

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Google and Facebook increasingly competitive

Google and Facebook appear set on expanding into each others territory: Google is trying to move closer to the social graph via initiatives such as Google Wave, and to move closer to the transaction via initiatives such as Product Listings. Google has also signaled a less cooperative relationship with Facebook by preventing Gmail users from automatically uploading their Gmail contact lists into Facebook. While we expect Facebook to rely on Bing rather than develop a standalone search engine, we think that Facebook will increasingly seek to differentiate Bing through creative use of Facebooks social graph information. Facebook has launched an e-mail service that competes with Gmail, as well as other mail services, such as those from Yahoo!, AOL, and MSN.

Google and Facebook have noted that the two can be complementary, citing Facebook as a major traffic driver to Googles YouTube site. However, we estimate that YouTube generates less than 4% of Googles gross revenue, and believe that the broader theme is one of competition rather than cooperation.

Amazon and eBay seeking to leverage Facebook

In comparison, the major e-commerce sites appear to enjoy a more complementary relationship with social networks. For example: Amazon recently launched an integration service with Facebook, which: o o o o Provides media (books, music, movies) recommendations based on ones Facebook profile. Highlights friends upcoming birthdays, and enables one to see friends Amazon Wish Lists, to encourage birthday presents. Explores friends profiles to look for similar interests. Does not share purchase history or account information.

eBay provides a Group Gifting service with Facebook, which designates one person as the organizer to choose a gift, and invites others to contribute funds.

A question which we discuss in more detail below is whether e-commerce companies will not only launch integrated services on social networks, but also shift advertising spend from search and toward social networks.

We expect Facebook may challenge Google in two of the three ways that Google currently dominates the Web
Googles centrality to the World Wide Web and sector-leading profitability flow from three factors, in our view. The status of Google as the dominant search engine. The status of search engines as the dominant means of navigating the Web. While this statement may appear tautologous, directories such as Yahoo! represented the dominant means of navigation during the 1990s. The status of Google as the dominant provider of contextual advertising on third-party websites.
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While the three factors are somewhat linked (Googles leadership in search provides it with relationships with advertisers which in turn help it succeed in contextual advertising), they are also somewhat discrete, and we believe Facebooks threat to Google will vary by factor.

A. We do not expect Facebook to challenge Google in search

We see limited risk of Facebook disrupting Googles search business directly given: Googles competitive advantages in search arise due to its infrastructure capacity (bandwidth and servers enable fast delivery of results), algorithmic expertise (honed over years), and traffic lead (which informs Google which results to serve up). Persistent consumer willingness to use one service for search and another for social networking, which we have observed not only in Google-dominated markets but also in non-Google, non-Facebook markets such as Russia and China.

We see moderate risk that Facebook providing Bing with user information will help Bing pick up some search share at Googles expense. In November 2010, Bing disclosed that it would use Facebooks data feed for Bing users signed into Facebook to: Highlight search results that ones Facebook friends have liked. Because the average user possesses 130 Facebook friends, and because only a minority of friends might like products within each category, the number of queries which benefit from this feature could be small. Improve the relevance of results for people searches. Such searches account for about 4% of Bings queries.

We view these features as incrementally positive for Bings search traffic, and thus negative for Googles, but not as major share-shifters given their limited-use cases, and given Googles incumbency and brand advantages.

B. We expect Facebook will take share from Google in contextual advertising

Contextual advertising = brand advertising based on website content
Googles AdSense for Content service enables advertisers (initially small advertisers who belonged to its AdWords search program) to run contextually relevant advertisements on websites enrolled in Googles AdSense affiliate network. For example, an online retailer of dog food might advertise dog food on blogs about dogs. Google pays out 68% or more of the advertiser revenue to the websites where the ads appear. We estimate AdSense for Content accounts for around half of Googles network revenue, or about $4 billion in 2010, and that listings were historically the majority of this revenue, with display ads catching up. By these estimates, contextual ads generate about 15% of our forecast $26 billion in total non-search online advertising in 2010 (see Exhibit 3).

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Exhibit 3: We estimate around $26 billion in global non-search online advertising in 2010E
$ millions
2009 Worldwide online advertising Year-over-year growth Worldwide search/performance advertising % of WW online ad Year-over-year growth Worldwide display & other advertising % of WW online ad Year-over-year growth 45,869 1.0% 26,426 57.6% 1.0% 19,443 42.4% 1.0% 2010E 57,691 25.8% 31,456 54.5% 19.0% 26,236 45.5% 34.9% 2011E 68,510 18.8% 37,393 54.6% 18.9% 31,117 45.4% 18.6% 2012E 79,495 16.0% 42,925 54.0% 14.8% 36,570 46.0% 17.5% 2013E 90,505 13.9% 48,673 53.8% 13.4% 41,832 46.2% 14.4% 2014E 101,750 12.4% 54,793 53.9% 12.6% 46,957 46.1% 12.3% 2015E 113,111 11.2% 61,541 54.4% 12.3% 51,570 45.6% 9.8%

Source: Company data, Erwin, IAB, IDC, Universal McCann, US Census, Goldman Sachs Research estimates.

We believe Facebook is well-positioned to compete in contextual advertising because: We estimate Facebook already serves over $1 billion per year of contextually relevant advertisements onto consumers profile pages within Facebook, providing it with a technology and advertiser base that it can easily extend to affiliate websites. Facebook possesses information about Internet users based on their Facebook disclosures, which can then be used to better target advertisements on affiliate websites. Whereas Google might serve the same clothing ad to all visitors to a college sports blog, Facebook could potentially serve college-specific clothing ads based on the schools attended by its users. Facebook currently allows advertisers to target users on the basis of: location, age, birthday, gender, keywords in profile information (such as job title), education, workplaces, relationship status, language, and connections.

Financial assumptions: We estimate Facebook could achieve $3 billion contextual revenue in 2015
Assuming Facebook starts serving contextual ads onto third-party sites during 2011, we estimate it might serve $300 million of ads in 2011. By 2015, we forecast total worldwide contextual advertising at $9 billion, Facebooks share at $3 billion, and Googles share at $6 billion (see Exhibit 4). Exhibit 4: We expect around $9 bn in total contextual advertising in 2015, with Google capturing around $6 bn (two-thirds) and Facebook generating around $3 bn (one-third)
$ mn
10,000
Contextual ad revenue ($ mn)

9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2010E 2011E 2012E Google 2013E Facebook 2014E 2015E

Source: Company data, Goldman Sachs Research estimates.

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Googles minimum TAC on AdSense for Content today is 68% (to the website owner), and we assume its average TAC is 75%, so that its net AdSense for Content revenue is about $1 billion in 2010E. If Facebook offers 85% TAC and some websites move from Google to Facebook, Google might also need to pay a higher TAC. Google has historically paid lower TACs than competitors but still delivered superior net revenue to websites because Google served the most relevant ads from the largest number of advertisers; we assume that Facebook could fully compete on relevance given its knowledge of user behavior. We estimate that AdSense for Content is thus 5% of Googles net revenue in 2010, and could be rather flat between 2010 and 2012. We view a period of no growth for 5% of net revenue as not very material fundamentally for a company otherwise growing overall net revenue 15%-20% per year, but are concerned investors could react adversely given that: Investors may extrapolate Facebooks ability to challenge Google in contextual advertising across to Googles core search business. Investors reacted poorly to Googles withdrawal from in-China search provision, which we estimate was a smaller business than AdSense for Content display.

C. We believe Facebook may develop into another web nexus

Yahoo!, the largest and most profitable online advertising company prior to the advent of Google, was originally called Davids and Jerrys Guide to the World Wide Web. Google pushed ahead of Yahoo! not by developing a better directory of interesting web sites, but by providing a more-popular means than the directory for consumers to find web sites.2 Similarly we think the risk that Facebook poses is not that Facebook develops a better search engine, but that Facebook provides a more-popular means than the search engine for consumers to find certain categories of web sites. See Exhibit 5.

A website from 2002, http://www.haystackinaneedle.com/faq/faq_directories.htm, explains differences between directories and search engines, and recommends that advertisers pay $299 per year to be included in the Yahoo! directory. It poses the Frequently Asked Question: Is it worth paying $299 to submit my site to Yahoo? and responds For most sites, Yahoo delivers over 15% of the sites traffic, so a better question is Can I afford not to submit my site to Yahoo?, before noting as an afterthought that emergent search engines such as AltaVista do not require submission payments.
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Exhibit 5: Facebook has increased its share of traffic sent to major e-commerce sites, though not at the expense of Google
Google and Facebook share of global page views, and as sources of traffic to selected websites (US data only)
Global page views Oct-10 Percentage of total Google sites Facebook 10% 9% 10% 6% Google Oct-10 Embedded sites Twitter Youtube Zynga Average embedded Informational sites CNN Digg NYT Digital Wikimedia WSJ Online Average informational E-commerce sites Amazon Best Buy eBay eHarmony Fandango Netflix Rue La La Zappos Average e-commerce Online travel sites Expedia Kayak Orbitz Priceline TripAdvisor Average online travel
Note: YoY changes rounded. Source: comScore.

Global unique users Oct-10 75% 49% Oct-09 75% 36% Facebook YoY 0% 12%

Oct-09

YoY -1% 4%

Oct-09 14% 16% 2% 11%

YoY -1% -2% 0% -1%

Oct-10 26% 20% 51% 32%

Oct-09 11% 8% 70% 30%

YoY 15% 12% -18% 3%

13% 13% 2% 10%

15% 23% 28% 49% 20% 27%

14% 31% 32% 48% 19% 29%

2% -8% -4% 1% 2% -2%

8% 6% 3% 4% 3% 5%

6% 4% 2% 2% 3% 3%

2% 2% 1% 2% 0% 2%

20% 17% 11% 9% 21% 12% 14% 22% 16%

20% 17% 12% 7% 20% 11% 7% 18% 14%

0% 0% 0% 2% 2% 1% 7% 4% 2%

8% 4% 5% 8% 6% 9% 7% 5% 6%

2% 2% 3% 5% 4% 4% 4% 1% 3%

6% 2% 2% 3% 2% 5% 3% 3% 3%

13% 11% 13% 9% 27% 14%

15% 8% 12% 10% 21% 13%

-1% 2% 1% -1% 6% 1%

2% 3% 3% 2% 2% 2%

1% 1% 1% 1% 1% 1%

1% 2% 1% 1% 1% 1%

1 - Embedded web sites

We believe that certain sites will naturally derive substantial proportions of their traffic from Facebook because they exist in a mutually-beneficial relationship with Facebook. For example: We view Zynga as effectively embedded because many consumers play Zynga games on Facebook.

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We view YouTube as somewhat embedded because many consumers link to YouTube videos on their Facebook profile pages. We view Twitter as somewhat embedded because many consumers link their Tweets to their Facebook profile pages.

2 - Informational web sites

Facebook has become an increasingly important supplier of traffic to informational websites. The contribution per website varies to some extent with the seriousness of the websites content. For example and per comScore, Facebook is 3% of traffic to the Wall Street Journal Online, but 6% of traffic to Digg.

3 - Transactional web sites

Among major transactional websites such as Amazon, eBay, Fandango, Netflix, and BestBuy.com, Facebook has moved from 1%-4% of upstream traffic in late 2009 per comScore to 4%-9% of upstream traffic in late 2010, putting it behind Google but ahead of Yahoo! or Microsoft. Among travel-related transactional websites, Facebook remains immaterial, at 2%-3% of traffic, behind all three search engines. We assume the sites where Facebook might first overtake all search engines, including Google, would be sites related to social activities such as attending the movies (Fandango) or dating (eHarmony).

Spontaneous versus influenced traffic

Looking at the growth rates above, we believe it is important to bear in mind that Facebook has almost doubled its time spent online in the last 12-18 months. So the fact that Facebooks traffic to a particular website has increased meaningfully over the same period may merely reflect more consumers visiting Facebook before they (coincidentally) visit the particular website, as opposed to Facebook getting better at directing traffic to that site. For an offline comparison, if CBS was upstream from 4% of NBCs viewing, most observers would conclude that those consumers were channel surfing and would have gone to NBC without CBS participation, not that CBS was driving audiences to NBC.

Facebook needs to drive transactions, not just awareness, to capture performance advertising
We believe that Facebook should be similarly effective to most entertainment or informational websites at display advertising stimulating brand awareness or brand loyalty hence how Facebook is already achieving about $1 billion per year in advertising revenue. Display advertising is about 45% of online advertising, and we expect Facebooks role in display advertising to grow with its traffic and its targeting technology. We focus here on the other 55% of online advertising, performance advertising, which is intended to stimulate consumers to an immediate transaction. Facebook poses disruption risk to search engines and e-commerce sites if it proves successful at capturing performance advertising dollars and stimulating transactions; if it only succeeds as a brand medium, then it largely poses a risk to display sites, such as Yahoo!. Given users are generally on Facebook to communicate with friends or be entertained, not transact, its success as a performance medium may in turn depend on how difficult it is to convert users from communications or entertainment mode to transaction mode. Offline examples of such conversions include home shopping TV networks and Tupperware parties. Online examples include Googles Gmail advertisements, which serve ads to users based on the content of their emails.

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We believe that Facebook will likely be more successful than Gmail for performance advertising purposes given: Facebook possesses more information about its users than Gmail, which has to guess facts that Facebook knows, such as ones age or home location. Facebook faces less entrenched competition than Gmail, which relies on capturing share from established incumbents such as MSN and Yahoo! mail. Consumers generally spend substantially more time on Facebook than Gmail.

What to watch for as signs of Facebook becoming a web nexus

We believe investors should look at Facebooks launch of new advertising formats and tools, announcements from big online advertisers that they are spending heavily on Facebook, and the presence or absence of user defections due to privacy issues as signs of Facebooks progress toward becoming a dominant web nexus. Specifically: Facebooks deployment of new advertising formats suitable for performance advertisements, and Facebook's deployment of new tools for tracking its users behavior and preferences across the web, such as the Facebook Like button. Announcements that major transactional website advertisers, such as Expedia and eBay, are increasing their spending on Facebook to tens of millions of dollars per year. Expedia and eBay spend a few hundreds of millions of dollars per year on advertising, much of it on search engines. However we caution that big online advertisers may choose not to disclose their increased spend on Facebook for competitive reasons. How willing the silent majority of Facebook users are to leave the service due to privacy concerns. We do not view privacy complaints per se as a major issue, as they typically reflect the views of a vocal minority of users who do not actually leave the service anyway.

Financial assumptions Facebook could capture $8 billion in performance advertising in 2015

We assume Facebook will see moderate success in converting users from communications mode to transaction mode, and will therefore capture a moderate share of the performance advertising market. We assume that Facebooks traffic, which is growing faster than Googles, will move up from around 9% to about 15% of time spent online by 2015, comparable to the rates achieved by Yahoo! at its prime in the United States, or by Tencents communications and social network platform today in China, while Googles share (including nonAmerican Google sites and YouTube), which has been flattening out at about 10%, will remain at about 10%. Facebooks time spent would thus be 50% greater than Google's (including YouTubes). See Exhibits 6-7.

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Exhibit 6: Facebook is rapidly closing the total time spent gap with Google sites
% share of worldwide total minutes spent online
12% 10% 8% 6% 4% 2%

Exhibit 7: and narrowing the unique user gap too, with around 600 mn versus Googles 1 bn
% share of worldwide unique users
80% 70% 60% 50% 40% 30% 20% 10% 0%

% of worldwide minutes spent

Nov-2009

Nov-2009

Jan-2010

Jun-2010

Jan-2010

Jun-2010

Jul-2010

May-2010

May-2010

Oct-2010

Jul-2010

Oct-2009

Oct-2009

Apr-2010

Feb-2010

Mar-2010

Feb-2010

Aug-2010

Sep-2010

Mar-2010

Apr-2010

Aug-2010

Google sites

Facebook

Google sites

Facebook

Source: comScore.

Source: comScore.

We assume that Facebook will be around 15% as good at driving transactions and so attracting performance advertising as Google. Thus Facebooks 15% of time spent would be worth about 2.25 points of performance advertising, while Googles 10% would be worth 10 points, so the performance market in total (including other search engines such as Yahoo!, Bing, and Baidu) would be about 17.25 points. Facebook may thus capture 13% of performance advertising. We forecast worldwide performance advertising rising from $31 billion in 2010 at a 16% CAGR to $62 billion in 2015. Facebooks share could thus be 13% of $62 billion, or about $8 billion (see Exhibit 8).

Exhibit 8: Facebook may capture around 13% of the performance ad market in 2015, with Google taking around 70%
$ mn
80,000
Performance ad revenue ($ mn)

70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 2010E 2011E 2012E Google 2013E Facebook 2014E 2015E

Other sites

Source: Company data, Goldman Sachs Research estimates.

Goldman Sachs Global Investment Research

Sep-2010

Dec-2009

Dec-2009

Oct-2010

0%

% of worldwide unique users

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We assume Facebooks gains are mostly at the expense of display and offline, partly at the expense of Google
Allowing for Google not being the only search engine, and for Facebook stimulating new advertisers to use performance advertising, we assume about one-quarter of Facebooks gains would be at Googles expense, so Facebook could reduce Googles search advertising revenue in 2015 by about $2 billion, or by 3%-4%. Search engines sell advertisements on an auction basis, so a loss of spending to Facebook could theoretically enable other advertisers who do not advertise on Facebook to reduce their spending on Google as keyword prices fall. In practice, we believe that few advertisers would stop spending on Google, and that many of those who spend on Google follow an ROI discipline (meaning if Facebook generates traffic and Google continues generating traffic, they will buy on both), so that the second-round impact would be modest. For example, we believe that Bing and Yahoo! have signed up more advertisers due to their recent adCenter/Panama platform combination, yet prices per click on Google have not suffered despite advertisers who were previously exclusive to Google now advertising on Bing and Yahoo!. The ROI discipline issue comes down partly to whether consumers conduct fewer searches on search engines because they are finding what they want through social networks. Given the analysis earlier, we assume that social network-stimulated transactions would partly complement and partly cannibalize search engine-stimulated transactions.

Existing Facebook revenue streams O&O display revenue and micropayments

We estimate $1 billion display revenue on owned sites in 2010
Facebook has already established itself as a major recipient of branded, or display, advertising on its own website, as opposed to performance advertising on its own website (see performance section above) or display advertising on third party websites (see contextual section above). In June 2010, Facebook CEO Mark Zuckerberg commented that 2010 revenue estimates of $1.0-$1.1 billion are not so far off in either direction.3 We assume that Facebooks display revenue is about $1 billion in 2010, and may grow to about $3 billion in 2015, a little greater than Yahoo!s display revenue of about $2.4 billion in 2010 (see Exhibit 9). Positive factors versus our estimates include: Facebook possesses more traffic than Yahoo! already, and we assume the gap will widen over the next five years. The overall display market should be about 100% larger in 2015 than 2010.

Negative factors include: Facebook lacks some of Yahoo!s high-yielding content-driven inventory that appeals to major advertiser categories, such as Yahoo! Finance and Yahoo! Autos. The likely fragmentation of display advertising over the next five years.

http://techcrunch.com/2010/06/22/facebook-revenues/
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Exhibit 9: We see Facebook capturing 6% share of the display/other online ad market in 2015, with Google at 16% and Yahoo! at 7%
$ mn
60,000
Display/other ad revenue ($ mn)

50,000 40,000 30,000 20,000 10,000 0 2010E

2011E All other sites

2012E Google

2013E Yahoo!

2014E Facebook

2015E

Source: Company data, Goldman Sachs Research estimates.

We estimate $300 million micropayment revenue in 2010

Facebook collects a 30% toll on micropayments made for services on its platform, such as purchases of virtual seeds in the Farmville game. Based on financial results at social game publishers, we assume that total spending on such micropayments may be about $1 billion in 2010, and that Facebooks share may be about $300 million. We model that figure growing at $200 million per year to about $1.3 billion in 2015, versus micropayment spending on Tencent (including social and casual games akin to Farmville, excluding massively multiplayer games akin to World of Warcraft) of about $2 billion in 2010. Positive factors versus our estimates include: Facebook operates mostly in higher-income countries than Tencents home market of China. Facebook will likely reach more consumers than Tencent, given its global reach.

Negative factors include: Facebook relies largely on third-party apps on which it collects 30% of micropayment value as revenue, whereas Tencent has relied wholly on first-party apps on which it collects 100% of micropayment value as revenue. Tencent charges for certain customization services, such as background wallpaper, for which Facebook does not charge.

Financial implications for Facebook, and for Google

Facebook could achieve $15 billion revenue, $4.6 billion operating profit in 2015
Given investor questions about Facebooks potential size and profitability, we attempt below to size its business, using a range of scenarios. Facebook is privately held and rarely comments on specific financial figures, so we base our estimates and hypothetical scenario analyses on media reports, industry publications, and other third-party sources. At the
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midpoints of our analyses (see Exhibits 10 and 11), we see the possibility that Facebook could achieve $15 billion gross revenue in 2015, including: $8 billion revenue from performance advertising on owned sites. $3 billion revenue from contextual advertising on third-party websites. $3 billion revenue from display advertising on owned sites, up from about $1 billion in 2010 and compared to Yahoo! achieving $2.4 billion in 2010. $1.3 billion revenue from Facebook collecting a 30% toll on micropayments associated with the Facebook site, up from about $300 million in 2010 and compared to Tencent achieving about $2 billion in 2010.

Assuming a 30% operating margin on this gross revenue (at the midpoint of our scenario analysis), higher than Yahoo!s margin and lower than Googles margin, Facebooks 2015E operating profit could be around $4.6 billion (see Exhibits 10 and 11). The analysis below is purely for illustrative purposes and, given limited disclosures by Facebook itself, we provide a range of scenarios around our base case. Exhibit 10: Hypothetical Facebook income statement, based on midpoints of our 2015E scenario analysis (see Exhibit 11)
$ millions

Facebook income statement Gross revenue Display ad revenue (on Facebook sites) % change yoy Contextual ad revenue (on third-party sites) % change yoy Performance/search ad revenue % change yoy User payments revenue (net) % change yoy Total gross revenue % change yoy Operating income % change yoy Operating margin (gross)
Source: Goldman Sachs Research estimates.

2010E 1,100 57%

2011E 1,540 40% 300 NM 500 NM 500 67% 2,840 103% 0 NM 0%

2012E 2,002 30% 1,750 483% 1,500 200% 700 40% 5,952 110% 446 NM 8%

2013E 2,402 20% 2,363 35% 3,750 150% 900 29% 9,415 58% 1,412 216% 15%

2014E 2,763 15% 2,717 15% 6,188 65% 1,100 22% 12,767 36% 2,873 103% 23%

2015E 3,000 9% 3,000 10% 8,000 29% 1,300 18% 15,300 20% 4,590 60% 30%

300 1,400 100% NM NM NM

In our scenario analysis (see Exhibit 11), we sensitize by the following to arrive at hypothetical operating profit figures for Facebook in 2015E.

Revenue
Our base case assumes the math above. Our lower case assumes that Facebook does not succeed in the performance advertising market. Our upper case assumes that Facebook achieves performance revenue equal to twice our base case assumption.

Margins
Our base case assumes 30% operating margins on gross revenue, between the levels achieved by large Internet company peers such as Google and Yahoo!.

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Our lower case assumes 25% operating margins, similar to our estimate for Yahoo! in 2011. Our upper case assumes 35% operating margins, closer to our estimate for Google in 2011.

Exhibit 11: Hypothetical Facebook 2015E operating profit, sensitized by revenue and margin scenarios
$ billions
Revenue ($ bn) Operating margin Cases Lower $7.3 Lower Base Upper 25% 30% 35% $1.8 $2.2 $2.6 Base $15.3 $3.8 $4.6 $5.4 Upper $23.3 $5.8 $7.0 $8.2

Source: Goldman Sachs Research estimates.

What might Facebook be worth?

Recent purchases of Facebook stock on secondary markets such as SharesPost4 imply that Facebooks market value is about $40 billion today; however we caution the liquidity on these markets means they may not be indicative of ultimate valuation.

We estimate Facebook could capture 5% of Googles revenue by 2015

Of our forecast revenue for Facebook, we estimate that: $2 billion of the $8 billion revenue from performance advertising on owned sites might be at the expense of Google, $1 billion at the expense of other search engines, and $5 billion at the expense of offline advertising. $1 billion of the $3 billion revenue from contextual advertising might be at the expense of Google, and $2 billion incremental. $2 billion of the $3 billion revenue from display advertising might be at the expense of display incumbents such as Yahoo! and AOL, and $1 billion incremental. All of the micropayment revenue would be incremental.

Facebook could thus reduce Googles revenue in 2015 by about $3 billion, or 5% of our current 2015 Google gross revenue forecast of about $57 billion. We assume the percentage impact on Googles 2015 profitability would be similar, as competition from Facebook for affiliates could reduce Googles margins on its contextual business.

SharesPost is an online marketplace for private investments, posting real-time transaction data and representing more than 30,000 institutional and individual investors. Transaction and valuation information is available to registered users; registration is free.
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Exhibit 12: Gross revenue comparison for large online advertising companies, 2010E-2015E
$ millions
60,000 50,000 40,000 30,000 20,000 10,000 0 Google 2010E
Internet company gross revenue Google % of total Yahoo! % of total Facebook % of total Total online ad revenue % change yoy

Internet company ad revenue ($ mn)

Yahoo! 2012E 2013E 2014E

Facebook 2015E
2014E 51,344 50% 6,256 6% 12,767 13% 101,750 12% 2015E 57,049 50% 6,500 6% 15,300 14% 113,111 11%

2011E
2010E 29,058 50% 6,321 11% 1,400 2% 57,691

2011E 35,059 51% 5,543 8% 2,840 4% 68,510 19%

2012E 40,047 50% 5,717 7% 5,952 7% 79,495 16%

2013E 45,695 50% 5,998 7% 9,415 10% 90,505 14%

Source: Company data, Erwin, IAB, IDC, Universal McCann, US Census, Goldman Sachs Research estimates.

What could Google do to avert the Facebook threat?

We believe Facebook is a more serious threat to Google than other Google rivals have proven because: 1. Facebook will likely capture more time spent online than Google. We believe Google can only neutralize this factor by building a comparably popular social network, as most people offline as well as online spend more time interacting with each other than interacting with information, something that would be difficult for Google to achieve. Even where Google previously enjoyed success with its own social network, Orkut, in India and Brazil, Facebook is now gaining on Orkut. We attribute Googles challenges to Facebooks good fortune, Googles cultural bias toward engineering rather than marketing, and, possibly, to consumers preferring to keep certain searches (from searching for surprise presents to searching for divorce lawyers) away from their friends and family. AOLs accidental release of search logs in 2006 provided ample personal information that users would likely prefer not appear on their Facebook Profile pages.5

http://plentyoffish.wordpress.com/2006/08/07/aol-search-data-shows-users-planning-to-commitmurder
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2.

Many people provide more shareable information to Facebook than they provide to Google. We believe Google can neutralize this factor if it can scrape social graph information from Facebook. Googles investment in Zynga likely represented a step toward scraping data such as Facebook friend lists, as well as a building block to an alternate social network. However we think that Facebook is in a sufficiently strong position relative to its apps providers that it can prevent them passing such information along to Google. More broadly, the challenge Facebook poses is not only its size relative to Google, but its size relative to every other social network, meaning consumers may be more likely to leave Gmail for another e-mail service than to leave Facebook for another social network.

That said, we believe the known unknown threat Facebook poses to Google is the single most important factor limiting Googles multiple expansion in recent months. While fighting a competitor with more traffic (per comScore) and greater public excitement (see The Social Network) may be a new experience for some Google employees, we believe that Google still enjoys a privileged competitive position relative to most media companies, inasmuch as we expect its core search business to generally hold share. We therefore think that Facebook concerns are already fairly reflected in Googles valuation.

A global perspective search engines and social networks around the world
Social networks send some traffic to e-commerce sites in China, less in Japan and Korea
Non-Google search engines and non-Facebook social networks are popular in several regions, notably East Asia (China, Japan, Korea) and the Former Soviet Union. Analyzing upstream traffic to East Asian e-commerce and online travel sites suggests that the Japanese and Korean social networks, Mixi and Cyworld, send relatively little traffic to local e-commerce sites, whereas China social network Tencent sends substantial traffic to China e-commerce sites, helped by major China e-commerce site Taobao not advertising on Baidu. We do not think the e-commerce sites spend much on Tencents social network tools either, though they do advertise on its portal.

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Exhibit 13: Social networks are moderately important traffic drivers in Asia
Sources of traffic to selected websites
Search engines Oct-10 Informational sites Sina Sohu Yahoo! Japan (homepage) Daum Average informational E-commerce sites Taobao Dangdang Amazon.cn Rakuten Ichiba Amazon.co.jp Gmarket Average e-commerce Online travel sites Ctrip eLong Average online travel
Source: comScore.

Social networks Naver Average 7% 12% Tencent 5% 9% 0% 2% 7% 0% 2% Mixi Cyworld Average 5% 9% 0% 2% 4%

Baidu 7% 12%

Google Japan

1% 8% 10% 1% 8%

1% 8% 7%

4% 8% 11% 9% 18% 7% 7% 13% 7%

4% 8% 11% 9% 18% 7% 9%

9% 6% 4% 0% 1% 1% 6% 1% 1%

9% 6% 4% 0% 1% 1% 4%

15% 14% 14%

15% 14% 14%

4% 7% 5%

4% 7% 5%

We believe Asia social networks have focused on micropayments, not advertising

Many of the Asia social networks were popular before the emergence of Facebook, but unlike Facebook they have relied more on user micropayments than advertising revenue, so they have promoted themselves to advertisers less than Facebook. We therefore think that even though social networks became prevalent in East Asia before the United States, the United States may be a better laboratory for assessing how effectively social networks can benefit from the booming dotCommerce opportunity.

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Reg AC
We, James Mitchell, CFA, Ingrid Chung and Adrianne Shapira, hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report.

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