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By Janet Yang, CFA | 06-18-2014 02:00 PM

Lynch: The Bigger Threat to Facebook

Given Facebook's strong network effect and high switching costs, its direct rivals are a smaller concern than something completely different that might divert users' attention away from social networks, say Morgan Stanley manager Dennis Lynch. Plus: Why Lynch lowered his Apple stake.

Janet Yang: I'm Janet Yang with Morningstar. Today we are at the Morningstar Investment Conference with Dennis Lynch from Morgan Stanley. Dennis, thanks for joining us.

Dennis Lynch: Thanks for having me.

Yang: At our panel we were talking about companies and their competitive advantages. One company I think that comes up a lot in investor's minds is Facebook. Can you talk about why Facebook is not the next Myspace or the next Friendster. Why does Facebook have staying power?

Lynch: I think first and foremost Facebook has a very powerful network effect and a very large user base. I think at this point with over 1 billion users at that scale I think, it's hard for me to imagine that it's going to get disrupted in the same way that Myspace did early on. People forget when you think about Google, there were plenty other search engines that were effective early on in history of the Internet. But Google, once it got that commanding lead and that market share really, it never looked back and stayed a dominant company.

I think that Facebook's gotten to that point, given the size of its user base. There are also very high switching costs. The people using Facebook are constantly contributing content to it, sharing their photos, things that are going on in their lives. The idea of switching entirely to another social network as a substitute or direct substitute for Facebook, we're not concerned about that specifically. If you think about what can happen with Facebook in the future and what could go wrong on the risk side of things, certainly other forms of entertainment things that capture people's minds and attention I think would be more what we are worried about. Maybe it's not specifically a social network but something, that leads to people spending less time there. But at least so far the data points have been very strong for the company, despite the fact they've introduced some more advertising to the newsfeeds and have benefited financially from that. And the stock price is starting to reflect those things.

Engagement or the amount of time people are spending on the company's site is still actually rising. And so all the metrics look really good there. We think that there's enough of a first-mover advantage and network effect in place that they won't be disrupted. But we acknowledge that just like anything there are other alternatives that could develop especially in the days we live in which tend to be high in terms of innovation, and the speed at which companies go from small to big is significant. We certainly have to keep an eye out for alternative forms of entertainment and time spent. But for now I think the idea that Facebook is going to be like Myspace and suddenly no longer be the kind of core social network is not a concern.

I think there are some concerns that have been overemphasized, things like the younger demographic. There's a lot of recent research that shows that they might not spend all their time on Facebook, but certainly it's one of their core social networks. So generally we're comfortable with its competitive position, knowing that the future has some uncertainty, and we have to keep an eye on alternative forms of entertainment.

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