Facebook pays $19 billion for WhatsApp.
My first thought when I saw that headline was Dan’s Morning Word Post from December 26th, in which he laid out the possibility of monster M&A marking a long-term market top:
So what would the last straw really be??? Most likely silly M&A. Back in January 2000, when sentiment could not have been better towards the prospects of any company transacting on the world wide web, Time Warner, a bellwether in traditional media made a $160 billion merger agreement with America Online (AOL). For the kids out there, Google America Online, it was an internet service provider that also had a really cool thing called a web portal and an instant message service that was “yet to be monetized”. Make no mistake about it, that was the top at least from a sentiment standpoint, despite tech stocks having one last widow-maker rally before topping out in mid March, but that was the day most market historians will point to as the day the tech bubble was pricked.
Sounds like that time has, astoundingly, come once again.
Since yesterday evening’s announcement, I’ve read numerous articles detailing the rationale for FB paying $19 billion for WhatsApp (the best and most balanced from the FT). Some compare it to Google buying Youtube or eBay buying PayPal, or Microsoft buying Hotmail. But all of those acquisitions were in the $400 million – $2 billion range.
$19 billion is an entirely different price tag. What could be a terrific investment if you pay $1 billion (Instagram, which still doesn’t make money, but let’s give it the benefit of the doubt for comparison’s sake) might be a disastrous investment if you pay $20 billion.
Before I go totally bonkers on why I think the price tag is nuts, let me lay out a few snippets from some smart tech people about the possible rationale:
From Ben Evans’ blog (he works for Marc Andreesen’s venture capital firm AZ16):
WhatsApp has 450m active users, of which 72% are active every day. It has just 32 engineers. And its users share 500m photos a day, which is almost certainly more than Facebook.
So It’s quite possible mobile social will have lots of services indefinitely. This creates opportunities, but also a pretty basic challenge to Facebook. Partly in response, it paid first 1% of its market value for Instagram and now close to 10% for WhatsApp, taking not dominance but at the least two of the commanding heights of mobile social. That’s the right way to think about value, I think – not ‘OMG $16bn!”, but “is this worth 10% of Facebook?’ The deal values WhatsApp users at $35 each (very close to what Google paid for YouTube, incidentally), but the current market cap of Facebook values its MAUs at $140 or so.
There are now roughly the same number of smartphones and PCs on earth – those PCs are mostly shared and immobile or locked-down corporate boxes, while the smartphones are mobile and personal.
This scale is at the heart of the valuations we’re starting to see – WhatsApp is probably now sending more messages than the entire global SMS system.
Of course, many of the users that Facebook acquired through WhatsApp are likely already on Facebook as well, so a lot of overlap using the value per user metric.
From Om Malik of Gigaom.com, who is also optimistic:
When I think about the deal, it actually makes what investor Paul Kedrosky calls “ridiculously rational” sense. It keeps WhatsApp out of the hands of Google and most importantly takes out an aggressive competitor for “attention” from the market.
Facebook is going to end up competing with apps like Line and WeChat in many markets for the consumer’s mobile minutes and WhatsApp gives the Menlo Park based company a strong competitive weapon. While potential monetization remains a bit of a head scratcher, there are more options for the company to think about, like new native advertisements in the near future.
Mr. Malik then goes on to discuss other historical acquisitions (Hotmail, ICQ, Skype) and acquisition strategies (CSCO using expensive stock during the tech bubble to stave off competition) that supports Facebook’s move.
And guess who is the new photo leader according to recent numbers? WhatsApp. According to the company’s own numbers, WhatsApp is processing 500 million images per day, compared to 400 million Snapchat (“snaps”) per day, which could include photos or videos. For its part, Facebook processes a comparatively paltry 350 million photos a day, with an additional 55 million per day from Instagram.
Facebook has become the world’s most dominant, and resilient, social network by ensuring that it “owns” photos. Today’s purchase shows they’re determined to maintain that dominance whatever the cost.
Finally, Sequoia Capital, an early investor in WhatsApp (clearly biased to pump up the acquisition, though that’s really true of everyone in Silicon Valley, since one crazy valuation raises everyone’s valuations), detailed some of the positives in yesterday’s blog post:
Here are four numbers that tell the story of WhatsApp: 450, 32, 1 and 0.
450. WhatsApp has more than 450 million active users, and reached that number faster than any other company in history. It was just nine months ago that WhatsApp announced 200 million active users, which was already more than Twitter.
32. Even by the standards of the world’s best technology companies, WhatsApp runs lean. With only 32 engineers, one WhatsApp developer supports 14 million active users, a ratio unheard of in the industry. (WhatsApp’s support team is even smaller.)
1. Jan keeps a note from Brian taped to his desk that reads “No Ads! No Games! No Gimmicks!” It serves as a daily reminder of their commitment to stay focused on building a pure messaging experience.
This discipline is reflected in WhatsApp’s unconventional approach to business. After one year of free use, the service costs $1 per year — with no SMS charges.
0. There may be no greater testament to the viral nature of WhatsApp than the fact that the company has accomplished all this without investing a penny in marketing.
All of these are wonderful anecdotes. WhatsApp sounds like a terrific company with a stellar management team and engineering wizardry.
But I simply don’t see how any of it justifies a $19 billion valuation!!!!
For any investment, at the end of the day, cash flow is king. Maybe not today, maybe not tomorrow, but eventually, I want to see your cash. Granted, FB paid for most of the deal with stock, so the acquisition could also be that Zuckerberg and Co. see their own stock as overvalued. However, whatever the long-term plan for WhatsApp, I have a very hard time envisioning the long-term cash flow stream that justifies $19 billion of value out the door today. Do you think WhatsApp has better long-term cash flow prospects than the following companies, all worth less than WhatsApp?
Most incredibly, no one seems to be concerned about one of the principal tenets of investing – Barriers to Entry! Warren Buffett always emphasizes investing in companies with big moats because competition is a major risk for any profit-machine. Well, WhatsApp has 55 employees, and was only started in 2009. Doesn’t sound like much of a barrier to new entrants to me.
I’m Turkish-American, and most of my cousins in Turkey use WhatsApp. But if WhatsApp charged money or put advertisements on its service, many of them would simply switch to the next messaging service. Many were using Viber 2 years ago, and are familiar with Line and WeChat as well.
With so much competition out there, monetization of so many users (most with little disposable income) is going to be much more difficult in my opinion than current mobile investors (and Facebook) seem to think. While the existing network effect has some value (you’d need your friends to switch from WhatsApp to a new service too), since WhatsApp is just a service rather than a platform or storage space, you wouldn’t lose anything by switching to the new service other than some short-term inconvenience.
Low Barrier to Entry is a huge risk in my view. Meanwhile, $19 billion assumes a very rosy scenario, while significantly discounting that huge risk. Good luck to Zuck – he’s going to need it in spades.