Obviously the SMS business has been a cash-cow for mobile operators for close to 20 years now, and it was high time that something happens to shake-up the status quo. This seems to be exactly what the WhatsApp team has managed to do. No surprise that it didn’t get unnoticed. On 19th February 2014, Facebook announced that it had agreed to acquire WhatsApp, a 50-staff company, for $19 billion (about 20% in cash and the rest in equity).
This looks mind-boggling at first. But WhatsApp currently has 450 million (mobile) users world wide. Also, in view of recent social media transactions, the pricing of the WhatsApp acquisition does not look so crazy. Sure, the Zuckerberg ‘kid’ and his shareholders must know what they are doing?
At the time of writing, listed social media companies such as Facebook, LinkedIn and Twitter are valued at about $100 per user. Back in 2006, Google acquired Youtube at a price of $33 per user, and Facebook’s recent announcement values WhatsApp at about $42 per user. So far, so good. But does that mean that WhatsApp has been priced at ‘fair value’? Or was is too expensive? Or too cheap?
If WhatsApp is not valued on a stand-alone basis but for the synergies and increase in customers that it brings to the Facebook business, then coming up with $19bn might not be hard at all. First, Facebook was valued at $158bn at December 2013, or $128 per user, with 1.23bn users. At that price per user, you have to add 148m new users to Facebook’s existing user base to get to $19bn. Second, and vice-versa: many Facebook users are potential WhatsApp users, so increasing the WhatsApp user base to 1bn+ sounds feasibly. Third, if WhatsApp manages to monetise its audience, this opens the door for Facebook to an alternative way of generating revenues: this time directly from end users (on a recurring basis, not one off!), and not from advertising (the very large majority of Facebook revenues today).
If you value WhatsApp on a standalone basis, you have to be very bullish to come up with $19bn. Though not entirely impossible, it is rather hard. We have set up a simple Discounted Cash Flow (DCF) model to check what you have to believe to value WhatApp at $19bn. We have then run a number of simulations. An overview of the results is provided below.
Assuming $1 ARPU per annum per paying user, 90% EBIT margin, 30% tax rate, a WACC of 15% and a perpetuity growth rate of 5%, you need to get a lot of users (2bn+) and a lot of them as paying users to come close to a $10bn valuation.
Even assuming 2bn users and 90% paying, in order to get to the $15-20bn valuation range, you need to be much more bullish about the ARPU level, and keep assuming that the EBIT margin would remain extremely high, as shown in the following table.
Even then, if Facebook spends $19bn on WhatsApp and still wants to create value for existing Facebook shareholders (say 20% IRR within 3-5 years, i.e. 2X over the period), what kind of assumptions does Mr Zuckerberg actually make to turn his $19bn acquisition into a $38bn business? That looks like mission impossible, unless you charge 1.8bn WhatsApp users $5 per annum, as shown above.
There is one thing you can be certain about: Mobile Network Operators won’t give up the profitable SMS business without a good fight. Mr Zuckerberg, watch out!