Essay Facebook Whatsapp Deal

(Reuters) - Facebook Inc will buy fast-growing mobile-messaging startup WhatsApp for $19 billion in cash and stock in a landmark deal that places the world’s largest social network closer to the heart of mobile communications and may bring younger users into the fold.

The transaction involves $4 billion in cash, $12 billion in stock and $3 billion in restricted stock that vests over several years. The WhatsApp deal is worth more than Facebook raised in its own IPO and underscores the social network’s determination to win the market for messaging.

Founded by a Ukrainian immigrant who dropped out of college, Jan Koum, and a Stanford alumnus, Brian Acton, WhatsApp is a Silicon Valley startup fairy tale, rocketing to 450 million users in five years and adding another million daily.

“No one in the history of the world has ever done something like this,” Facebook Chief Executive Mark Zuckerberg said on a conference call on Wednesday.

Zuckerberg, who famously closed a $1 billion deal to buy photo-sharing service Instagram over a weekend in mid-2012, revealed on Wednesday that he proposed the tie-up over dinner with CEO Koum just 10 days earlier, on the night of February 9.

WhatsApp was the leader among a wave of smartphone-based messaging apps that are now sweeping across North America, Asia and Europe. Although WhatsApp has adhered strictly to its core functionality of mimicking texting, other apps, such as Line in Japan or Tencent Holdings Ltd’s WeChat, offer games or even e-commerce on top of their popular messaging features.

The deal provides Facebook entree to new users, including teens who eschew the mainstream social networks but prefer WhatsApp and rivals, which have exploded in size as private messaging takes off.

“People are calling them ‘Facebook Nevers,’” said Jeremy Liew, a partner at Lightspeed and an early investor in Snapchat.

How the service will pay for itself is not yet clear.

Zuckerberg and Koum on the conference call did not say how the company would make money beyond a $1 annual fee, which is not charged for the first year. “The right strategy is to continue to focus on growth and product,” Zuckerberg said.

Zuckerberg and Koum said that WhatsApp will continue to operate independently, and promised to continue its policy of no advertising.

“Communication is the one thing that you have to use daily, and it has a strong network effect,” said Jonathan Teo, an early investor in Snapchat, another red-hot messaging company that flirted year ago with a multibillion dollar acquisition offer from Facebook.

“Facebook is more about content and has not yet fully figured out communication.”

PRICE TAG

Even so, many balked at the price tag.

Facebook is paying $42 per user with the deal, dwarfing its own $33 per user cost of acquiring Instagram. By comparison, Japanese e-commerce giant Rakuten just bought messaging service Viber for $3 per user, in a $900 million deal.

Rick Summer, an analyst with Morningstar, warned that while investors may welcome the addition of such a high-growth asset, it may point to an inherent weakness in the social networking company that has seen growth slow in recent quarters.

“This is a tacit admission that Facebook can’t do things that other networks are doing,” he said, pointing to the fact that Facebook had photo-sharing and messaging before it bought Instagram and WhatsApp.

“They can’t replicate what other companies are doing so they go out and buy them. That’s not all together encouraging necessarily and I think deals like these won’t be the last one and that is something for investors to consider.”

Venture capitalist Sequoia Capital, which invested in WhatsApp in February 2011 and led three rounds of financing altogether, holds a stake worth roughly $3 billion of the $19 billion valuation, according to people familiar with the matter.

“Goodness gracious, it’s a good deal for WhatsApp,” said Teo, the early investor in Snapchat.

Facebook pledged a break-up fee of $1 billion in cash and $1 billion in stock if the deal falls through.

Facebook was advised by Allen & Co, while WhatsApp has enlisted Morgan Stanley for the deal.

Shares in Facebook slid 2.5 percent to $66.36 after hours, from a close of $68.06 on the Nasdaq.

“No matter how you look at it this is an expensive deal and a very big bet and very big bets either work out or they perform quite poorly,” Summer said. “Given the relative size, the enterprise valuations this is a very significant deal and it may not be the last one.”

Our Standards:The Thomson Reuters Trust Principles.

Reporting by Garry Shih and Sarah McBride in San Francisco; Additional reporting by Soham Chatterjee in Bangalore, writing by Edwin Chan, Editing by Savio D'Souza, Andrew Hay, Peter Henderson and Lisa Shumaker

Can a text messaging service have the same value as a company that produces life-saving cancer drugs? According to Facebook, the answer is yes. When the firm announced on Wednesday that it is purchasing Mountain View, Calif.-based WhatsApp for $19 billion — $16 billion in cash and stock, and $3 billion in restricted stock units — an article in Bloomberg noted that such valuations have only ever been given to firms that develop drugs for illnesses such as cancer and Crohn’s disease.

WhatsApp enables users to create profiles to share text messages, photos and videos over their smartphones. With 450 million monthly users, the service is expanding rapidly in Africa, Asia and Latin America. The WhatsApp acquisition would give Facebook a much needed foothold in emerging markets, where its presence is lacking, analysts say.

Currently, WhatsApp’s service is free for the first year, and then $1 for each year thereafter. In a statement following Wednesday’s announcement, Facebook founder and CEO Mark Zuckerberg said that WhatsApp is “on a path to connect one billion people” within the next few years. At the current fee, that could eventually mean $1 billion in annual sales for Facebook, Bloomberg noted. (In a previous Knowledge@Wharton story, Wharton faculty warned that Facebook inevitably will need to find revenue streams beyond advertising in order to avoid alienating users.)

“WhatsApp is the only widely used app we’ve ever seen that has more engagement and a higher percentage of people using it daily than Facebook itself,” Zuckerberg added. (According to CNET, the engagement rate of WhatsApp’s monthly users on a daily basis is 70%, whereas Facebook’s is around 61%.) Given the potential upsides, however, does the deal make sense at such a steep price? Knowledge@Wharton asked two Wharton experts — Kartik Hosanagar, professor of operations and information management, and Lawrence G. Hrebiniak, emeritus professor of management — whether they believe the move ultimately will pay off.

Kartik Hosanagar:

“For Facebook, the acquisition makes sense for several strategic reasons, which I outline below. The valuation is hard to justify from a purely financial standpoint. In my opinion, the valuation reflects [the fact] that … Facebook was willing to pay whatever was needed to keep WhatsApp away from competitors such as Google. Secondly, Facebook has been aggressive in identifying the next big trends and startups in social [media] and trying to acquire those companies before they can eventually become serious threats to Facebook — for example, Instagram. So, Facebook paid a premium to bring a potential long-term threat in-house. So, to me, the valuation was less about financial upside but reflected a nice defensive move by Facebook.

“Now, why did acquiring WhatsApp make sense in the first place? One reason is opportunities: Growth for Facebook is going to come from emerging markets, where WhatsApp is very strong. Messaging is important for Facebook, and it has invested a lot in its standalone messenger app. Further, WhatsApp comes with [an existing] revenue model, which I suspect Facebook will not toy around with.

“There is another trend worth noting here. For a while now, Facebook has acknowledged that a one-size-fits-all Facebook doesn’t make sense going forward. People want to share different types of content with different users. There are several use cases for which Facebook is not ideal, and that creates an opening for an entrant to come in and take over the social networking space. This is especially true in mobile and, in response, Facebook has built separate apps for separate use cases (as opposed to those use cases that are features within Facebook). For example, Facebook launched Facebook Camera, and later acquired Instagram when the Camera app did not take off. It also launched Poke [a pared-down form of instant messaging], and then made an offer to acquire SnapChat when Poke failed. [Recently, the company] launched Paper, an app for news. [It also] launched its standalone messenger app. Now, it has acquired WhatsApp.”

Lawrence G. Hrebiniak:

“Facebook is paying $19 billion for a messaging company with 55 employees — a cost of approximately $345 million per employee. They must be really special and talented! The firm is buying a company with [minimal] revenue and one that has eschewed an advertising-revenue model…. Is the hot messaging technology worth such a huge amount? Is this a good move or a form of insanity? Let’s consider a few facts or motives.

“Facebook’s growth has slowed, and WhatsApp is growing — which speaks positively for the acquisition. Both of the companies are in the same business [social networking], but the communication methods or technologies are different, so Facebook is adding some new capabilities — which, again, is good. Facebook may also be trying to limit competitors’ options — for example, making a first move to keep Google and others from getting into their competitive space.

“I’m still not convinced, however, about the logic of the deal. What is the projected business model for the combined companies? Will monetization or revenue generation become a reality? Is it worth $19 billion to keep Facebook relevant and fresh in the market? $19 billion is roughly a third of Ford Motor Company’s and HP’s market cap — is this reasonable, or is the bubble inflating? There may be a strategy here, but it eludes me at the moment. The price seems way overboard, especially when put in the context of other acquisitions in the communications arena. I wish Facebook luck, but this feels like a dumbfounding deal that looks overpriced and risky.”

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