MorningWord 2/20/14: Social Media Companies Are Scared $hitless That They Could Become Myspace $FB, $TWTR

by Dan February 20, 2014 9:28 am • Commentary

The best offense is a good defense, right?

Reading through the initial postmortems on why Facebook made such an aggressive bid for messaging service WhatsApp, the obvious conclusion for the price tag was to make a knockout agreement so that competitors like Google or Microsoft would be out of the game.  Those postmortems don’t make much of a case as to how the service would be accretive to FB’s earnings at any point in the next decade.  (Read Enis’s thoughts below)

There were some interesting reactions last night to the news.  As one would expect, FB was trading lower as they are depleting cash and using their stock as currency to make what will be a widely dilutive acquisition.  Just how much it should be down would be a guess, but given the speculative nature of the market and the sector, I wouldn’t be surprised to see the stock make a new high in the coming hours or days.

Blackberry immediately traded up at least 5% as some want to try to assign a value to their BBM messenger service that has been recently rolled out in global app stores to be used on other operating systems.  For those still trying to delineate the sum of the parts for this pig, they were happy to extrapolate the roughly $40 per WhatsApp user value assigned by FB’s purchase price to BBRY’s supposed 80 million BBM users.

Using that thought process, shouldn’t AAPL’s iMessage users be assigned some value?  Market research indicates that there are around 300-400 million active iPhone users around the world (and around 800 billion active Android users), so just the messaging aspect of the phone is worth $15 and $35 billion respectively, right? Right?

For those of you who are active on Social Media & mobile messaging services, this acquisition should not come as a huge surprise.  Recently Instagram (also owned by FB) made direct messaging a new focus of the App, putting the functionality front and center on the main screen.  Twitter, who I have yet to mention, did the same, making their Direct Message (DM) function also on the main screen both on mobile and desktop.

So the big boys are going after a service that will be very hard to monetize, especially because the valuations paid for such assets are becoming absurd.  FB’s April 2012 $1 billion purchase of Instagram turned out to be a home run.  And why? Clearly, and in hindsight, because of what they got it for, relative to FB’s market cap now (about $170 billion as of last night’s close).  At $19 billion though, the math is a bit different.

So what’s it all mean? To me, it is obvious that publicly traded social media companies are scared shitless. Many of their executives and board members wake up in the middle of the night in cold sweats with a recurring nightmare that they are about to become MySpace.

What happens from here?  GOOG which is floundering in Social, could make a $40 billion bid for TWTR (GOOG has $60 billion in cash and with their stock at all time highs, why not use it as currency).  While TWTR’s user growth and engagement numbers clearly have plateaued, maybe they could be massively jump-started with a network affect with GOOG’s hundreds of million Gmail users.  Or maybe TWTR and YHOO merge as YHOO’s more than 800 million monthly active users (350 million plus on mobile) could catch some synergies.  Oh, and then there is MSFT with a new CEO who is charged with changing their course.  Remember a few years ago MSFT paid over $8 billion for call and messaging service Skype?  There has to be some synergies there with some other Social Media services yet to be explored before they end up writing down that acquisition.

The possibilities are endless, but make no mistake, this is not the last of it.  I would expect to see many of the smaller WhatsApp competitors to be gobbled up.

Putting price aside, I suspect this was a necessary deal for FB as they are more worried about engagement with the youths than they have let on and Zuck being a recent youth himself realizes the potential of a finicky consumer base.




Original Post Feb 20, 2014 at 7:18am:  Macro Wrap – The Last Straw?  Silly M&A!  $FB Buys WhatsApp

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, 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.

Sarah Lacy of Pando points to photos as the key reason for the acquisition:

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.