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Facebook’s $19bn WhatsApp buy: bubble or bargain?


By Tony Walford, Founder

February 20, 2014 | 8 min read

We’re all used to Silicon Valley giants paying sky-high prices for tiny companies yet to make a profit, but $19bn?

Unless you’ve been in some sort of news-free bubble in the last day or so, you will of course have heard that yesterday (late last night UK time), 19 February, Facebook paid $19bn for WhatsApp. That’s right, nineteen billion dollars. For a small company employing around 55 people that makes one app. The deal was structured thus: $12bn in Facebook shares, $4bn in cash and a further $3bn in restricted shares which could vest over the next few years if all goes according to plan. WhatsApp’s founders and senior executives are going to become very rich.

What’s particularly striking about this deal – apart from the fact that it was such a surprise, and that the idea of buying it was only floated less than a fortnight ago – is that WhatsApp was, rather optimistically, according to some, valued at “just” $1bn this time last year; and that Google allegedly put in a bid for that amount, which was turned down.

So what’s in this deal for Facebook, and what does it mean for the rest of us? Leaving aside for a moment the hugely inflated price (in my conversations over the past day or so I’ve not come across anyone who doesn’t think this is an extraordinarily high price to pay), it’s clear that Facebook’s latest – and biggest – acquisition is also its most important.

We all know that the net is moving from the desktop to mobile devices, and that communication has to be near-instantaneous. But Facebook’s investors have often found the company’s mobile strategy unconvincing. The photo-sharing service Instagram, which it bought back in 2012, only added to this disquiet and last year it missed out on acquiring another messaging service,SnapChat, for $3bn. This deal sends out a clear message to investors and rivals: “We’re serious about mobile."

What Facebook must do – for the moment at least – is leave its new acquisition well alone. As soon as news of the deal was made public, social media – Twitter especially – was awash with worried WhatsApp users making it very clear that any attempt to introduce advertising to their favourite app would cause them to dump it. And WhatsApp has made it very clear, on its own site and elsewhere, that it “hates” advertising.

To be fair to Facebook, I think it's well aware of this. Last night Facebook supremo Mark Zuckerberg said that WhatsApp would remain an independent business; the team would stay at their base in Mountain View, California (where, incidentally, Facebook’s great rival Google is based), although WhatsApp co-founder and CEO Jan Koum will join the Facebook board.

So how do Zuckerberg and co. monetise their new baby? Actually at the moment, WhatsApp can make money. If the numbers are to be believed, the service is gaining one million new users a day, and has 450 million users, 350 million of whom are active on any given day. The service charges a flat fee of $1 (or £1) per year after the first year of use – so that’s several hundred million dollars on the Facebook balance sheet already. Not a huge amount in the grand scheme of things, but a tidy sum nevertheless and probably not a bad multiple if we just look at the $4bn of cash that has been paid for the business given Facebook has a lot of cash laying about. However, when taking the shares issued into consideration and the fact that Facebook’s share price fell $1.82 on announcing the deal, it has some way to go before paying for itself.

In the final analysis, buying WhatsApp is actually more important than how to monetise it in the short term. Facebook’s biggest problem is losing people, and if it is to hold on to its pre-eminence, its numbers have to grow. It has about 1.2 billion users but, as it approaches ubiquity, it becomes less appealing to younger people (why would a 16-year old want to share a platform with his or her parents, or even grandparents?) In any case, those younger people are moving to instantaneous messaging platforms, of which WhatsApp is the most important.

So, the new acquisition gives Facebook inroads into a younger demographic (who may migrate onto Facebook itself or it may slow their attrition) and, just as importantly for long-term growth, emerging markets. WhatsApp’s genius is that it allows users to exchange messages, pictures and the like without incurring roaming charges or text costs – in relatively impoverished regions this could prove to be extremely attractive. Although, oddly enough, WhatsApp is relatively unknown in the US, it’s very popular in Europe and South America, with penetration approaching 80 per cent in some countries.

WhatsApp is also growing fast – we’ve already mentioned that it’s gaining about a million users a day, which means it’s growing faster than Twitter or any other messaging service (and Facebook itself). The general consensus is that it is on course for a billion users within the next couple of years.

And, let’s not forget, Mark Zuckerberg is no fool. Facebook is, despite the criticisms levelled at it over the years, a smart company. Some time ago the company’s leadership realised that its core social network offering was not enough. It’s becoming clear that its strategy to is to build, or acquire, a family of applications. WhatsApp is ideal for users who want to communicate one-to-one or in small groups, rather than in wider networks. As a service, it’s also easier to use and more elegant than Facebook’s own messaging offer.

There’s something else too. Telecoms companies make billions from SMS text and similar services. Could Facebook be looking to siphon off some of that money? One analyst estimated that using WhatsApp could save some users over $150 a year in charges. Even if the flat subscription fee is doubled (or some other multiple), WhatsApp would be extremely attractive to many heavy users of SMS, especially the young. It could also be linked to bank accounts to make micro-payments – in China, the use of social messaging services to make purchases is starting to take off.

So, there’s no doubt that WhatsApp is a valuable acquisition. But did Facebook overpay? Even in the context of overinflated valuations of tech companies, it probably did.

WhatsApp has been in existence for fewer than five years, employs mostly engineers and outsources much of the heavy lifting to Russia, where talent is plentiful and cheap. As far as I’ve been able to discover, it has only received about $8m in funding during its short life. It’s a cool and very good product, but the company doesn’t have a huge amount of patents or IP.

Stung perhaps by SnapChat rejecting its advances, Facebook probably decided it would snaffle its next target no matter what. It was an acquisition it probably felt it HAD to make. And this huge deal isn’t necessarily the start of a bubble – nobody else in Silicon Valley, apart from Apple (which has always been very cautious when it comes to acquisitions), Microsoft and Google has the kind of balance sheet that allows buyouts of this scale. As mentioned previously, Facebook shares fell by $1.82 on news of the deal – the markets obviously thought WhatsApp massively overvalued – but I expect it may recover over time.

Nineteen billion dollars is a great deal to pay. But what would the cost have been to Facebook had WhatsApp fallen into someone else’s hands? It’s often said that Facebook won’t be around in 10 years’ time. In the form we know it today, it probably won’t, because the world – and the tech world especially – moves on and quickly. But Facebook as some kind of messaging, sharing, telecoms or payments hub probably will still be around. Buying WhatsApp for such a vast amount of money was definitely a gamble, but in business, you often have to take risks to assure yourself of a future.

Tony Walford is a partner at Green Square, corporate finance advisors to the media and marketing sector.


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