Wall Street sees sense in Facebook's $19 billion WhatsApp

By Soham Chatterjee and Saqib Iqbal Ahmed Thu Feb 20, 2014 4:39pm EST A Whatsapp icon is seen on a Samsung Galaxy S4 phone screen with a Facebook logo in the central Bosnian town of Zenica, February 20, 2014. REUTERS/Dado Ruvic WhatsApp is worth it - analysts (01:26) Related Video Video WhatsApp is worth it - analysts Video What's up with WhatsApp Facebook deal? Video Does not compute? Facebook’s WhatsApp deal by the numbers (Reuters) - Facebook Inc's purchase of fast-growing messaging startup WhatsApp for an eye-popping $19 billion largely won approval from analysts, who said the deal made strategic sense as it will solidify the social network's position as a leader in mobile. Facebook shares closed up 2.3 percent at $69.63 after falling as much as 3 percent in early trading as investors got over the initial sticker shock of the deal value. At least two brokerages downgraded their recommendations on Facebook to "hold" but the overwhelming majority of analysts remain positive on the stock. WhatsApp is much stronger than Facebook Messenger in Europe, Latin America, Africa and Australia and has attracted users at a time when it appears that young people are turning away from Facebook. Facebook is paying more than double its annual revenue for a chat program that has little revenue. The purchase price is slightly more than the market value of Sony Corp. But analysts noted that WhatsApp has over 450 million users and boasts a higher level of engagement than Facebook. "Facebook is the leading global social-sharing utility. Now, it has a significant opportunity to be the leading global communications utility," RBC Capital Markets said in a note. Analysts said the price tag for WhatsApp, founded in 2009 by former Yahoo Inc employees Jan Koum and Brian Acton, seemed reasonable from the point of view of value per user. Facebook is paying $42 per user, compared with a market value per user of $170 for Facebook and $212 for Twitter, Deutsche Bank's Ross Sandler said. Analysts estimate WhatsApp users share 19 billion messages, 600 million photos, 200 million voice messages, and 100 million video messages per day. WhatsApp's user base is less than half that of Facebook's 1.2 billion but the chat program's users are more active. On any given day, 70 percent of WhatsApp users are active, compared with 62 percent for Facebook. WhatsApp's users are expected to reach 1 billion by 2015, according to many analysts. "Looking past the sticker shock of $19 billion ... We view (the deal) as an offensive move to gain additional share of the consumer's time spent," Credit Suisse analysts said, noting that Facebook was paying about 11 percent of its market value to gain a 30 percent rise in engagement. HAVE SCALE, WILL MAKE MONEY Of the 44 analysts who cover Facebook, 37 have a "buy" or a "strong buy" rating on the stock, according to Thomson Reuters data. None has a "sell" rating. Analysts have commended Facebook's ability to make money from its mobile app. Now they will want to see how it will earn money from the chat app's huge number of users. "While we don't expect messaging to be a meaningful near-term or even long-term revenue driver, the real value could be the evolution of the platform to incorporate new functionality such as payments, app distribution, social features ...," Macquarie Equities Research analyst Ben Schachter said. Facebook has fallen behind in mobile phone messaging apps in emerging markets, where many are accessing the Internet on fast-growing 3G mobile networks for the first time on smartphones. Asian rivals such as Tencent Holdings Ltd's WeChat, Naver Corp's Line and Rakuten Inc's Viber are well ahead of Facebook messenger across much of Asia. Facebook has been buying apps with large numbers of young users as part of Chief Executive Officer Mark Zuckerberg's strategy of helping users share any kind of content with anyone. The company's $1 billion deal to buy photo-sharing application Instagram in 2012 and its recent $3 billion failed overture to buy SnapChat - used by teenagers to send texts and photos that disappear after a few seconds - followed unsuccessful attempts to develop rival apps. "Large-scale networks like WhatsApp are rare and provide (a) significant monetization opportunity (i.e. YouTube) justifying valuation over time," SunTrust Robinson Humphrey's Robert Peck said in a note. Still, some analysts said Facebook was paying a high price to keep WhatsApp from being snapped up by a rival such as Google Inc. "Facebook shares would have been pressured by more than single-digit percentages in after-market trading if Google had purchased WhatsApp instead," Stifel analyst Jordan Rohan said in a note. Pivotal Research's Brian Wieser, who downgraded his rating on Facebook shares to "hold" from "buy," said he expects Facebook shares to face pressure in the near-term as investors come to terms with the risk of future acquisitions. (Reporting by Soham Chatterjee and Saqib Iqbal Ahmed in Bangalore; Editing by Saumyadeb Chakrabarty and Lisa Shumaker) ================= Context News How it works By Peter Thal Larsen Facebook says WhatsApp can double its active user to 1 billion. But how much do those users have to pay to justify the messaging app's $19 billion valuation? There are two inputs in blue: the number of WhatsApp users who pay for its service - which the company does not disclose - and the amount it squeezes out of them per year, currently $1 a year. The calculator assumes WhatsApp hits its 1 billion target and that annual costs - which we currently estimate at $50 million - rise less quickly. The output in red shows WhatsApp's 2016 earnings multiple, and compares that to Facebook's own valuation. Facebook on Feb. 19 said it had reached an agreement to buy mobile messaging service WhatsApp for up to $19 billion in cash and stock. The social network led by Mark Zuckerberg is paying $4 billion in cash, about $12 billion in Facebook shares and $3 billion in restricted stock units, to be granted to WhatsApp’s founders and employees, that will vest over four years. WhatsApp, founded in 2009, says it has over 450 million people using its service each month, 70 percent of whom are active on any given day. Mark Zuckerberg, Facebook’s chairman and chief executive, said he believed that WhatsApp was on track to hit 1 billion users. WhatsApp charges users $1 a year to use the application, after a one-year free period. The company declined to say how many customers pay the fee. For mere mortals who haven’t partaken in whatever Kool-Aid Mark Zuckerberg is serving at Facebook’s Hacker Way headquarters, is there any way to justify the $19 billion it is paying for WhatsApp? It takes extraordinary suspension of disbelief – and a new Breakingviews calculator – to see how the social network can bring the messaging startup’s valuation in line with its own.

Any fact-based analysis is handicapped by a paucity of hard numbers. WhatsApp says it has 450 million active users and is adding 1 million new users per day. The app is free for 12 months, after which it costs $1 a year. WhatsApp doesn’t say what proportion of its customers pay. What’s clear, however, is that it has, for the time being, no other sources of revenue: WhatsApp has foresworn advertising.

Say Zuckerberg is right and WhatsApp reaches 1 billion users by 2016. Costs are probably low: rival Viber, which has fewer users, spent around $30 million in 2013. Assume WhatsApp, which has about 50 employees, currently spends $50 million on overhead, servers and bandwidth this year. Maybe that rises to $75 million by 2016. If the ban on advertising remains, WhatsApp’s valuation boils down to how many customers will pay and how much they’ll spend. At the moment, the proportion is probably low. If WhatsApp is to justify its price tag, it needs to increase both. Over time, if it could convince a tenth of users to pay, it would equate to 100 million people. At $1 a month – well above today’s $1 a year charge – it would yield net income of $675 million in 2016. That’s equivalent to 28 times Facebook’s purchase price, the same multiple the market puts on the social network’s stock. Equally, if an improbable 800 million people pay $1.50 a year, the valuation could also stack up.Charging a bit for messaging sounds plausible, especially if it undercuts existing mobile phone charges. But such apps are ubiquitous and the barriers to switching relatively low. The financial logic for buying WhatsApp can be modeled, but requires a big quaff from Zuckerberg’s punchbowl.