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.

Analysis: After Web stocks boom, investors wary but rout unlikely

Analysis: After Web stocks boom, investors wary but rout unlikely Sun, Dec 29 09:03 AM EST image By Alexei Oreskovic and Rodrigo Campos SAN FRANCISCO/NEW YORK (Reuters) - For investors in internet stocks, it was a banner year: shares of many companies doubled as revenue climbed and on forecasts for rip-roaring growth in earnings. But the gains haven't been anxiety-free, thanks to uncomfortable memories of the 1999 Internet bubble and subsequent bust. Market strategists and tech experts say the comparison is overblown. While there is the potential for a decline in some Web company stock prices that are out of line with their earnings outlook, they say there is little chance of a bloody retreat. Most importantly, this year's stars, such as Facebook and Netflix, actually make money. Many of the web companies that were emblems of the previous era had little prospect of ever being profitable and some hardly had any revenue - basing their boasting on non-financial metrics such as numbers of eyeballs, or page clicks. The Internet and the ways people use and access it have been transformed in the past 14 years. In 1999, it was mainly through slow dial-up services using a desktop computer, now there is faster broadband and mobile access from phones and tablets. Web-based advertising has grown into a mature, viable business, and computing speeds support video and sophisticated gaming. The market is much more rational than it was in 1999, argues Jeff Dachis, who co-founded and was chief executive of Razorfish, an online ad firm that went public in 1999, and is now part of France's Publicis Groupe. "What you had then was 100 times the volume of stock with little to none of the credibility or weight in the marketplace that a Facebook or a Twitter has today," said Dachis. "Nobody denies now the growth of online advertising or digital marketing." WARNING SIGNS Facebook, Google and Netflix are among the internet companies set to finish 2013 at or near record highs. Less-weighty Web companies such as Yelp and Pandora saw their shares triple. That is not to say there aren't warning signs. The 160-percent gain in shares of Twitter since its November initial public offering raises awkward questions about the levels of speculative froth given the company has not yet earned a cent. Also, consumer names like Snapchat and Pinterest are raising eyebrows by garnering millions of dollars in financing at multi-billion dollar valuations - despite being decidedly in the red. According to CB Insights, there are 26 U.S. tech companies that have raised financing at valuations of $1 billion or more and that could go public in 2014, including Uber and Square. Hedge fund manager David Einhorn, who has often taken short positions on richly valued stocks, in October asked in a letter to investors whether history was being repeated. "When ... conventional valuation methods no longer apply for many stocks, we can't help but feel a sense of déjà vu," he said. Still, internet companies are trading at much cheaper valuations than their counterparts in the late 1990s. The stratospheric multiples that defined companies such as Webvan (388 times revenue in 1999) and VerticalNet (268 times sales) are unheard of today. Twitter, which trades at 73 times its past year's revenue, is among the most richly valued Web stocks by that measure. Google, Netflix and Salesforce.com all trade at below 10 times their trailing twelve-months' revenue. "The end markets - internet advertising, online retail, online travel - those markets are just dramatically more developed today than they were in ‘99, 2000," said Mark Mahaney, who began his career covering internet stocks in the 1990s at Morgan Stanley, working with star internet analyst Mary Meeker. TOIL AND TROUBLE The bursting of the dotcom bubble ranks among investment history's greatest debacles. From its peak of 5123.52 on March 10, 2000, the Nasdaq Composite Index lost 78 percent of its value in just over two-and-a-half years. Nearly 14 years later, the Nasdaq has still not regained those lofty levels even as most other major U.S. averages have surpassed previous highs, another indication that the market is far from where it was back then. The turn of the decade came replete with stories about extravagant parties, unabashed flogging of dubious names by investment professionals and startup CEOs, and tales of cash outlays that boggle the mind today, including a Super Bowl 2000 that saw nearly 20 dotcom companies spending about $1.1 million apiece on advertising spots - just before many went under. At the end of 1999, 8 out of 10 of the most highly valued stocks were tech companies, led by Yahoo trading at almost 577 times projected 2000 earnings, according to S&P Dow Jones Indices. Fellow dotcom-era corporations America Online and Cisco Systems Inc - the latter prized because it dominated the market for networking equipment that enabled internet connections - clocked in at 223 times and 102 times, respectively. Fast-forward to 2013, and just four dotcoms rank among the year's 20 biggest gainers on the S&P 500, led by Netflix's quadrupling. Yahoo is at No. 10 after having doubled. Facebook has more than doubled. Other big gainers include Best Buy and Micron Technology. "The consensus view in the market is that things are bubbly but since the valuations are not as expensive as 1999, there is room to run," said Mike O'Rourke, chief market strategist at Jones Trading. But he said such thinking may be flawed and cautioned that using one of the most expensive periods in stock market history as a comparison is extremely risky, with a limited reward. "When bubbles pop a large portion of the gains are erased very quickly," O'Rourke said. IPOS MUCH FEWER The lack of newly listed internet stocks provides some relief for those concerned about a possible bubble. There were only five U.S. internet IPOs in 2013, including Twitter, compared with 86 in 1999, according to Thomson Reuters data. In fact, the number of IPOs in 1999 is greater than the combined number of public offerings every year since then. Many companies may simply be waiting longer to take the plunge, debuting at a far more advanced stage of development than the wave of 1999 dotcoms. Facebook, an extreme example, went public with a valuation of more than $100 billion. "Anything and everything - regardless of how asinine the business model was - was going public and getting ridiculous valuations" back in 1999, said Ryan Jacob, chief executive of the Jacob Funds. Take eToys, the online toy store whose shares quadrupled on their debut in 1999. It spent tens of millions of dollars on pricey TV ads only to file for bankruptcy in early 2001. With low interest rates and signs that the U.S. economy is strengthening, internet valuations could go higher in 2014 - though nowhere close to 1999 levels, Jacob says. He points to LinkedIn's 14 percent decline since more than doubling in the first nine months of the year, as sign that investors aren't losing their heads. "You did have a part of the market that got ahead of themselves, and then took a breather" in 2013, Jacob said. (Editing by Edwin Chan, David Gaffen and Tim Dobbyn)