The Next Billion

Edited by Vani Rao

Facebook logs in to WhatsApp to dominate messaging on phones and the web

FB - Whatsapp LogoFacebook Inc. (NASDAQ:FB) announced on 20 February 2014 that it has reached an agreement to buy popular instant messaging application WhatsApp for $16 billion. The deal involves $4 billion of cash, about $12 billion in Facebook shares, and $3 billion in restricted stock that would be available to WhatsApp staff if they remain employed by Facebook for the next four years. Prior to this, Facebook’s costliest acquisition was Instagram, which it bought for $1 billion in 2012.

Co-founder and CEO of WhatsApp Jan Koum will join Facebook’s Board of Directors, but WhatsApp will continue to operate independently within Facebook, much like Instagram. WhatsApp was founded by college dropout Jan Koum and Stanford alumnus Brian Acton. Interestingly, despite a dozen years of experience at Yahoo Inc. (NASDAQ:YHOO) and Apple Inc. (NASDAQ:AAPL), Brian Acton was earlier turned down by Twitter and Facebook when he wanted to join these two companies.

WhatsApp has over 450 million monthly users, of which nearly 70% are active daily users. The app claims to add nearly one million new users per day and is apparently the fifth most downloaded app on Android devices. The messaging app had received a funding of US$8 million from Sequoia Capital in 2011.

Similar to traditional text messaging, WhatsApp allows people to connect via their cellphones. However, instead of charging users for texting messages, WhatsApp sends the actual messages over mobile broadband. This makes WhatsApp particularly cost effective for communicating with people overseas.

The biggest appeal of this instant messaging app that works across all smartphones is that it was nearly free, barring the low cost of a basic mobile data plan, unlike an SMS text message. In short, WhatsApp did to SMS what Skype did to international phone calls.

Buying WhatsApp will bolster Facebook’s already strong position in the crowded messaging world. Messenger, Facebook’s standalone messaging app for mobile devices, is second only to WhatsApp in terms of market share in the smartphone segment.

Source: comScore Media Metrix
Source: comScore Media Metrix

Is the Deal Worth the Money Splurged?

Is WhatsApp worth $19 billion? By financial metrics, the answer is no. The purchase price is insanely high for a start-up with only 55 employees, and many multiples of Facebook’s reported $3-billion bid for Snapchat last year. The $19-billion valuation means that Facebook believes WhatsApp is worth over $42 per user. The company would need to increase its circa $50 million annual revenue more than hundred times, something its business model is clearly unequipped to acheive. Major companies that have market caps under $19 billion include: United Continental (NYSE:UAL), Gap Inc. (NYSE:GPS), Ralph Lauren (NYSE:RL), Marriot International (NASDAQ:MAR), Xerox Corp. (NYSE:XEX), and Moody’s (NYSE:MCO).

The deal has received flak from analysts as they believe that the deal does not solve Facebook’s real problems, which involve building a bigger audience to attract more advertisers, learning what its audience wants, and keeping its audience engaged to attract more advertisers. However, many feel that Facebook’s money is well spent, given the huge growth potential in the instant messaging domain.

The Next Billion Users

Facebook CEO Mark Zuckerberg has different ideas and he sees the strength in WhatsApp’s numbers. “WhatsApp is on a path to connect one billion people. The services that reach that milestone are all incredibly valuable,” he said in a statement.

Moreover, Facebook has achieved a staggering 1.2 billion active monthly users, but the social network is suffering from stagnating growth. Facebook has a far reaching presence in the US and much of Europe, but is struggling to gain a foothold across India, Latin America, and Asia. Mark Zuckerberg referenced this specifically: “There are countries [such as] Korea or Japan where another messaging service is bigger. But if you look across the world, WhatsApp across Europe, Latin America, India, a lot of places in Asia is the clear leader.”

Mobile Ad Revenues

Facebook’s revenue from mobile ads has been increasing over the past few quarters. In its Q4 2013 earnings, Facebook reported earning 53% of its ad revenue from the mobile segment. The mobile segment accounted for nearly $1.37 billion of its total $2.59 billion revenue in Q4. This is an increased from Q3 2013, when the social media giant had reported that 49% of its ad revenue came from mobiles. In the recent past, Facebook has been facing stiff competition from mobile messaging apps. Given this scenario, adding WhatsApp to its mobile portfolio strengthens Facebook’s mobile offering and consolidates the clicks it had been losing to the chat app.

Keeping Competition in Check

A view of Facebook’s past acquisitions including Instagram, its recent acquisition could be seen as efforts to keep competitors at bay. This is because WhatsApp and Instagram both had the potential of emerging as independent strong platforms that could at some point prove serious threat to Facebook.

Source: Company data
Source: Company data

Terms of Engagement

“WhatsApp is the only app we’ve ever seen with higher engagement than Facebook itself,” admitted Zuckerberg said in a conference call to journalists yesterday after the deal was announced. This is crucial because it isn’t just users that Facebook wants; it is highly engaged users passionate about the platform. This is a key difference between WhatsApp and Snapchat. You don’t typically send 20 SnapChat pictures a day, but it is not uncommon to send 20 WhatsApp messages during a day.

It is a scenario that also applies to Skype, Twitter Direct messages (thanks to its restrictions), and Hangout, which requires a Google account. Only SMS and Facebook Messenger can claim similar engagement levels; the former cannot be bought, while Facebook already owns the latter.

WhatsApp was a Warning Shot

Combined Facebook, Instragram, and WhatsApp will bring Zuckerberg close to two billion active users. Obviously, there will be a significant overlap, this trio will give Facebook a significant user base in just about every major country across the globe. While announcing the deal, Zuckerberg declared his ambition of “connecting the world’s people”.

“Once we get to being a service that has a billion, two billion, three billion people one day, there are many clear ways we can monetize,” he said. He now has the chance; however, even under Facebook’s ownership, WhatsApp should be remembered as a warning: it grew to 400 million users and a $16-billion valuation three years after its launch. If Facebook gets its strategy wrong, another rival will likely grow even faster.

In the event that the merger fails to obtain regulatory approval, Facebook has agreed to pay a breakup fee of $1 billion in cash and issue Class A common stock worth another $1 billion to WhatsApp.

For WhatsApp, the messaging app that grew on its ‘No ads, no games, no gimmicks’ gameplan, is now catapulted to the big league with this deal. Until WhatsApp’s green icon does not turn blue or it does not stop evolving like it did in its independent days, the messaging app is safe to make the transit.

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