Trying to Justify $19B for WhatsApp

How on earth did Facebook arrive at the princely sum it paid for the mobile messaging company?
Vincent RyanFebruary 21, 2014

Nineteen billion dollars is almost $2 billion more than the entire budget allocated to NASA last year. It’s about a billion shy of the market capitalization of Tesla Motors. It’s one-half-year’s worth of advertising revenue on the entire internet (if you’re talking 2013).  It’s almost three times Facebook’s total 2013 revenue. And apparently, it’s the amount of money the social media giant would pay to get 450 million monthly active users of a mobile messaging company (at $42 per user).

Why did Facebook pay such a hefty sum (and, assuredly, a big premium) for WhatsApp, a cross-platform mobile messaging company? Richard Waters, writing in The Financial Times, notes that one data point provided by Facebook is that texting is a $100 billion-a-year business. And no one can deny WhatsApp is special: as The Financial Post reports, WhatsApp handles more than 19 billion messages per day, equivalent to the total worldwide volume of SMS text messages. What’s more, 70 percent of WhatsApp users are active daily.

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9344676230_a8d9af9016_zGreat, but, as Waters points out, you can throw out that $100 billion number, because that is what telecom providers earn from SMS services. (If a mobile phone user doesn’t have a text-message plan, they can pay up to 20 cents a message.) WhatsApp is disintermediating telecoms by making its service free or nearly free (users pay 99 cents annually after the first year). What’s left to justify $19 billion, then, is the grand notion that WhatsApp is “designed to get Facebook over the chasm that lies between the desktop past and mobile future,” as Waters puts it. Any company that can do that is extremely valuable, at least to Facebook, despite the lack of real performance numbers to plug into a valuation model.

Indeed, according to Bloomberg, at $19 billion, WhatsApp is being valued like a miracle cure for Facebook. At about 19 times estimated sales (assuming the service grows to 1 billion users), WhatsApp is at “a multiple investors currently only bestow on companies developing life-saving drugs” for things like cancer and Crohn’s disease, according to Bloomberg.

But let’s come back down to earth a minute. As valuation guru and New York University professor Aswath Damodaran has pointed out more than once on his blog, it is a myth that you can’t value young growth companies with some mathematical rigor, that in these instances value does not matter or is merely a function of what the market thinks. “No matter what the promise or potential of a company, the stories eventually have to show up as numbers (revenues and earnings), and if perception is at odds with reality, it is perception (price) that will change, not reality,” Damodaran writes.

Thankfully, as I put this post together, Professor Damodaran wrote his own post on the valuation of WhatsApp. Here’s a taste: “Looking for fundamentals to justify the price paid but I realized very quickly that this would not only be futile but frustrating and here is why. To justify a $19 billion value for a company in equity markets today, you would need that company to generate about $1.5 billion in after-tax income in steady state.” Using its current business model, WhatsApp would need a user base three or four times its current one and zero operating costs (impossible) to produce earnings like that, Damodaran says.

Of course, there’s the other side of the coin too. You can’t always use traditional metrics to value a company like WhatsApp. One of Damodaran’s other myths is that all growth companies are overvalued. “If your measure of value is to apply a constant PE (say 12) to next year’s earnings or to use a stable growth dividend discount model to value equity, you will never find a young, growth company to be a bargain,” he says.

Still, we maintain that, even with Facebook’s inflated currency (its stock), it paid full price for WhatsApp, and one day it’s going to have to produce a return from the deal. Shareholders will want more than a large, engaged user base to show for their investment. When that day comes, we’d rather have paid a price closer to what Rakuten, a Japanse company, paid this week to buy Viber, a free text messaging app. The $900 million price Rakuten paid values Viber at $8.57 per user (based on 105 million monthly active users).

At that valuation per user, WhatsApp would have cost Facebook close to $4 billion, which is the amount of cash Facebook ponied up in the deal. No chump change, for sure, but a little easier investment to show a decent return on, and, perhaps, a little cushion of safety if things don’t go as perfectly as planned. But Facebook must see a whole lot more value in WhatsApp than anyone else does. If Facebook’s management is able to extract all the value they forecast from this deal, they will have a heck of a story to tell: in their eyes, WhatsApp could be the bargain of the century.

Photo: Flickr user Sam Azgor, CC BY 2.0