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Part II – Analysis of Facebook’s Acquisition of Whatsapp

February 28, 2014
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This blog is an extension of our blog on Analysis of Facebook's Acquisiton of Whatsapp

Will Facebook save its face and book any profits from this deal?
A million dollar question…and I am scared …my answer is no, in fact a BIG “NO”….

I can understand the desperation behind this acquisition but probably not at a gold’s price. The deal might have saved the future of Facebook but probably may not be profitable. Let’s first look at what Facebook offered to WhatsApp for the deal:

facebook to acquire whatsapp

Let’s look at the key deals in the internet / IT space and the valuation attached to them.

key deals in the IT space and the valuation

Business Model of WhatsApp:

  • There is hardly any business model

  • Users are allowed to use it free for a period of year and then it’s chargeable @ 99 cents ($ 1) per annum

  • A back of the envelop calculation suggests that it will take Facebook an eternity to break even unless it does something spectacular with this asset

  • User base is growing fast. Let’s assume that it hits 1 bn user mark by early next year and in steady state all the users are paying the charge. It translates into an annual revenue of $ 1 bn. These assumptions are highly optimistic but let’s give the benefit of doubt to the target.

breakevn period calculation

This is the situation when I have assumed entire PAT will translate into free cash flow and time value of money factor has been ignored.
Further to understand the magnitude, let’s look at following:

  1. The transaction translates to roughly 11% of Facebook's market value.

  2. Google's biggest deal till date is its $ 12.5 bn purchase of Motorola Mobility.

  3. Microsoft's largest deal till date is Skype at $ 8.5 bn.

  4. Apple, meanwhile, has never done a deal above $ 1 bn.

  5. Facebook, itself has never done such a huge deal in its history. The biggest deal it has done so far is acquisition of Instagram for $ 1 bn. The deal now seems like a bargain in retrospect. Capturing mobile users - and young people - was a big reason behind Facebook's 2012 purchase of the photo-sharing app.

  6. Even if we consider the failed bid of Facebook to acquire Snapchatin its reported $ 3 bn, the deal appears to be too big for Facebook.

The only way Facebook appears to be making some sense of this transaction is by making changes to the business model of WhatsApp:

  1. Do something to increase retention; people continue to use it and ultimately start paying for the annual charges from second year onwards

  2. Increase the annual usage charges gradually from current $ 1 / annum to $ 3 / annum in due course of time.

I have done a set of calculations using reasonable assumptions to effect what I have said above. The same has been produced below:

equity valuation of facebook

Facebook needs to generate roughly $ 2.8 bn in revenue in terminal year to break even. Even if these things materialize, it will take Facebook lifetime to break even because that’s exactly the price it has paid upfront for acquisition.

Another metric that can be used for benchmarking is the price paid per employee:

price paid per employee

If Facebook really wants to save its face and book some profits from this deal then it must take following approach:

  1. Make WhatsApp a source of advertising revenue also – looks difficult because this is not in line with the thoughts of the original founders – they have intentionally kept this platform neat, clean and free from advertisements, gimmicks and stickers.

  2. Succeed in migrating the user base or a part of it to Facebook and earn from advertising revenue there. But still Facebook needs to generate $ 2.8 bn in 5 years’ time to justify the valuation.

While no one really knows what went inside the mind of Facebook’s CEO when he decided for the deal, there is at least one underlying variable that makes the deal look reasonable and even acceptable. That’s the user base.

relative valuation of companies

In many ways, Facebook's purchase of WhatsApp is similar to its 2012 Instagram acquisition.The $ 1 bn valuation invited criticism from investors of all classes at that time. But, with passage of time, young social network users gravitated towards photo-sharing services of Facebook and thus Facebook succeeded in probably nipping the competition at its bud only.

valuation per user of the companies

Intriguing, isn’t it? If you wish to add anything further to the blog, go ahead and post your thoughts in the comments section below!

This blog is to be continued. So stay tuned for more!

If you want to read about how Whatsapp generates revenue, go through our blog on How Does Whatsapp Generate Revenue?


About the Author

Shashi is a B.Tech from Indian Institute of Technology, Delhi and an MBA from Indian Institute of Management (IIM), Ahmedabad. With over 11 years of experience, he has dabbled in Project Management, Management Consulting, Investment Banking, Mergers & Acquisitions, Corporate Finance, Strategy Formulation and Fund Raising.


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