Feb 19 2014, 9:51pm CST | by Forbes
Even in this era of multibillion-dollar valuations for tech startups that have barely moved out of the founders’ parents’ basement, the idea of Facebook paying $19 billion for a mobile messaging service seems simply insane.
But that’s what Facebook likely will be spending to acquire WhatsApp , the latest–well, not even actually the latest–social network and communications service. The company today announced the deal, which includes $12 billion in Facebook stock, $4 billion in cash, and up to $3 billion in restricted Facebook stock units to be granted to WhatsApp founders and employees over a four-year vesting period.
Why so much for a service that a lot of people have never even heard of? Because it’s growing really, really fast –faster, in fact, than just about any similar service to date, including Facebook. More than 450 million people are using the service monthly, and 70% of them are active on any given day, according to Facebook’s press release . More than 1 million more are registering to use it every day.
Most stunning, WhatsApp messaging volume is apparently approaching the entire worldwide SMS messaging volume of mobile carriers. That’s the kind of growth Facebook, whose own messaging service has been growing rapidly but nothing like that, simply can’t ignore.
Still–$19 billion? Really? Some people thought Facebook CEO Mark Zuckerberg was crazy to offer $3 billion a few months ago for Snapchat, which has even more buzz than WhatsApp especially among the young people the No. 1 social network seems to be losing. If I’m not mistaken, it’s more than Google, Microsoft, Apple, or anyone else I can think of has paid for an acquisition. And Google just sold off its biggest acquisition, Motorola. (Well, there was AOL-Time Warner, long ago in Internet time, but you know how that turned out.)
It’s difficult to put a price on remaining relevant or even surviving long-term, so perhaps $19 billion isn’t that big a sum to pay . And it’s buying not only younger users, but users around the world . Given that everyone in the U.S. who wants a Facebook account surely has one, the company needs to make sure it goes deep into Europe and Asia if it wants to keep growing–and fulfill Zuckerberg’s over-arching goal of connecting everyone in the world.
And after all, it’s mostly stock–funny money in a sense. So why not spend it on ensuring a future for your company?
But no, I can’t say that with a straight face. It’s just too hard to justify it on any kind of near-term factor. Despite Facebook’s waning cool factor, the company doesn’t seem to be in significant danger. It’s one of the most profitable companies in the world at least measured by profit margin.
Investors aren’t so sure about the deal either. Shares were down about 3% in after-hours trading, though that’s a fairly mild reaction to such a big, surprising deal. In a note to clients, Pivotal Research analyst Brian Wieser downgraded Facebook shares to a hold because of share dilution and concern about further deals. Although he likes Zuckerberg’s new portfolio approach to apps, he also wonders about the price:
To justify $19bn, WhatsApp would need to generate around $1bn in annual cashflow by our model’s terminal year of 2018. However, few data-points to support such an assumption were provided by the company, as evidently few are available. As management indicated, it expects WhatsApp to focus on product and users rather than monetization, anyways. Conceptually, we agree with this notion given the sudden scale that WhatsApp achieved. Still, investors in Facebook will want to justify the valuation of such a transaction. On our own (crude) estimates, if we assumed the product had an average of 1bn users next year and added 100mm per year, with 25% of the user base at that time paying $2/year (we would assume many users will simply never pay, shifting devices and/or services as needed, while those who will pay might be willing to pay more than the current $1/year level), we could arrive at $650mm in revenue. $1bn is possible, but given the optimism already incorporated in a $650mm figure, it might seem a stretch.
The fact is, we can’t know today if this is a good deal for Facebook or not. Clearly Zuckerberg sees a big piece of Facebook’s future in WhatsApp, because he’s paying more than 10% of Facebook’s market cap for it, not to mention putting cofounder and CEO Jan Koum on its board. And he can’t make many more acquisitions of that size–perhaps any more, at least for awhile.
In a few years, Zuckerberg may well look smart, if his company ends up even close to as dominant a place for people to share their lives as it is today. It’s just hard to justify the deal on anything but faith right now.
Here’s what Zuckerberg had to say on a conference call this afternoon:
Our goal is to connect everyone in the world, he says in his usual mantra. To do that, the company has invested in a lot of mobile experiences. We want to develop new mobile experiences beyond the Facebook app.
WhatsApp doesn’t get as much attention in the U.S. because it got the most attention outside the U.S. It’s the only widely used app that has more engagement than Facebook, he said.
He also cited the successful subscription model it has. Simple, fast, reliable–it’s a great model for our own mobile experiences, he said.
Our chat is mostly used to communicate with Facebook friends, and not necessarily in real time, he noted, so WhatsApp is complementary.
Also on the call, Koum said his goal was to provide a service that could be used easily by anyone, no matter what platform. Some 19 billion messages a day are received (and 36 billion sent) using WhatsApp. (OK, so $1 for each message sent today–that’s what Facebook’s paying.)
In the Q&A session with analysts, the companies provided a little more color on the deal:
Zuckerberg said he and Koum have talked for about two years and that Koum was a “valuable thought partner.” Only the Sunday before last, Zuckerberg suggested joining forces. They talked price during the last week and it came together quickly. As announced, WhatsApp will be operated independently, like Facebook’s now piddling acquisition Instagram, while getting access to all of Facebook’s resources.
How will WhatsApp make money? Not ads, Koum said. (We’ll see.) Monetization won’t be a priority near-term and, in fact, the company won’t reveal how many of those 450 million users are paying $1 a year after the first year of free service. “We’re focused on the growth,” he said. For his part, Zuckerberg said WhatsApp is headed toward a billion users, and that’s always an extremely valuable market in some way or another.
Koum wouldn’t talk about other products that might come beyond messaging. Facebook Messenger will continue on its own, since Zuckerberg views it as quite different–only with Facebook friends and often not real-time.
One obvious question didn’t get asked: Why is WhatsApp worth $19 billion?
Anyway, Facebook helpfully provided the following chart to explain (if not excuse) why it’s willing to part with multiples of its annual sales on a company with 55 employees:
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