Whatsapp Acquisition

As the dust settles on the news of the acquisition, the focus will shift from focusing on the outrageous $19B price tag to understanding the rationale for the purchase. To put it in perspective, it's $600m/engineer, 50X returns for Sequoia or $42 for every user. Is it irrational exuberance? 

For a value based investing view, read Aswath Damodaran’s blog.

http://aswathdamodaran.blogspot.com/2014/02/facebook-buys-WhatsApp-for-19-billion.html

tl;dr below

• Value of equity = $19 billion
• Implied required return on equity, given how stocks were priced on 1/1/14 = 8.00% (a 5% equity risk premium on top of a 3% risk free rate)
• Steady state pre-tax earnings necessary to justify value = $ 19 billion *.08/ /(1-.30) = $2.17 B
• Higher the risk or lower the waiting period, larger the implied income.

There are several pathways to delivering these break-even earnings:

1. a)      Continue existing revenue model – WhatsApp charges $1 on an annual basis. If WhatsApp's user base continues to grow at 100% they will have 1B MAUs (monthly active users)  by end of 2014. Combine that with the 1.23B MAUs from Facebook who could potentially use WhatsApp. The user bases are largely complimentary with FB dominant in US/Europe and WhatsApp in India, Latin America and other emerging economies. Given that FB has its cross hairs on user acquisition, the user base will grow to justify the acquisition. Moreover FB could potentially charge more per user by integrating add on features. Say $2/user and 1B users could justify value.
2. b)     Advertising revenue from Ads - Facebook generates $6/user pa worldwide through advertising. If we were to assume that FB can extract the same ad $/user, it will take nearly 7 years to recoup the investment. However, ad revenue per user on mobiles (77% access FB on mobile) is less than PCs but more importantly WhatsApp has stayed away from ads and will likely do so in the near future. This is not to say FB will not be able to onboard these users onto their platform and charge for ads. Moreover FB could integrate add on services into WhatsApp in the near future. It’s no secret that Facebook has executed its mobile strategy flawlessly in 2012 and 2013 and will likely have a combined user base of 2B in the next 2-3 years. With 2B users, it will be easier to justify value.
3. c)      Get more users and revenue will follow – While an acquisition cost of $42 per user seems a lot, it pales in comparison with $130 per user for FB, given the $170B valuation for 1.2B MAUs. Depending on how you model it, the valuations could be wildly different.

Edit – Prof Damodaran’s blog is an excellent source, if you are interested in corporate finance and valuations (esp Beta's and market co-variance)

Beyond the numbers

Several articles explain the relations between valuations and number of users but the underlying theme for WhatsApp acquisition has been irrational exuberance. However there seems to be a method to the madness that can’t be solely explained by numbers.

1. a)      Teenagers – After much denial, FB finally admitted that they were losing teenagers. Capturing, WhatsApp users who are fairly young is vital for FB to stay relevant.  Number of likes and level of activity determines FB’s ability to price ads and compete with television for advertising supremacy.
2. b)     Emerging economies – FB has 50% of the 2B users who have access to internet. Majority of these users are in the developed countries and the remaining users are firmly entrenched in local social networks such as weibo, renren,wechat,vk.com etc. WhatsApp gives FB access to many of these countries that would be impossible otherwise.
3. c)      FB login – The battle between FB and Google for your information has only intensified with these companies offering ‘Login with Facebook’ or ‘Login with Google’. An easy process to log into any participating site but actually an attempt to capture your information to target relevant ads. Arguably WhatsApp opens the possibility for users to log into their accounts using FB login. Nearly a billion users potential logging and the associated network effects needs to be modeleda in the valuation.

So how does this affect Intel?

FB recently announced a consortium (Internet.org) to reach the next 5B users. Heavy weights such as Qualcomm, Mediatek,Nokia, Samsung, Ericsson and Opera are members of this consortium to make internet affordable to the masses by lowering the cost of the device and data. Without a mobile product intercept, Intel unfortunately in not a member of this consortium. Facebook’s WhatsApp deal can jumpstart Internet.org plans and wouldn’t be surprised if Mark Zuckerberg announces plans to introduce devices to strengthen the portfolio. Success of this consortium will preempt Intel’s ability to reach the 5B First Time Buyers in emerging countries where WhatsApp is very popular. Intel has to pay close attention to Facebook’s efforts and view them as market disrupters in the mobile space.