Facebook-WhatsApp: Show Me The Money

Social media platform Facebook has agreed a deal worth US$19bn for the acquisition of over-the-top (OTT) messaging mobile application WhatsApp. The amount is comprised of US$4bn in cash and approximately US$12bn of Facebook shares, with an additional US$3bn in stock to be distributed to WhatApp's founders and employees at a later date. BMI believes the deal fits with Facebook's mobile strategy and examines some of the risks the company faces as it looks to recoup its investment. We do not expect to see large changes for WhatsApp over the next year or two, but pressure to monetise the service will mount over the long-term.

In filing to the US Securities and Exchange Commission (SEC), Facebook noted that WhatsApp had around 450mn monthly users, adding around 1mn every day and expects the application to reach 1bn in the next few years. The acquisition represents the largest amount paid by Facebook, dwarfing the US$1bn of cash and stock it agreed for photo-sharing service Instagram in April 2012, with the rapid growth rate in users as likely to be the main reason behind the high price. It is also possible that Facebook was competing against Google for WhatsApp, as reports in April 2013 suggested that Google was prepared to offer US$1bn. Facebook may therefore have been forced to offer a higher offer to ensure it captured the platform instead of Google, indicating the value it places in WhatsApp. This is evident by comparing the price to that paid by Japanese e-commerce company Rakuten for a similar OTT chat service Viber, earlier in February 2014 equalling US$900mn.

Why Did Facebook Acquire WhatsApp?

Facebook Becoming A Mobile Oriented Company
Mobile Advertising As % Of Total Ad Revenue, 2012-2013

Social media platform Facebook has agreed a deal worth US$19bn for the acquisition of over-the-top (OTT) messaging mobile application WhatsApp. The amount is comprised of US$4bn in cash and approximately US$12bn of Facebook shares, with an additional US$3bn in stock to be distributed to WhatApp's founders and employees at a later date. BMI believes the deal fits with Facebook's mobile strategy and examines some of the risks the company faces as it looks to recoup its investment. We do not expect to see large changes for WhatsApp over the next year or two, but pressure to monetise the service will mount over the long-term.

In filing to the US Securities and Exchange Commission (SEC), Facebook noted that WhatsApp had around 450mn monthly users, adding around 1mn every day and expects the application to reach 1bn in the next few years. The acquisition represents the largest amount paid by Facebook, dwarfing the US$1bn of cash and stock it agreed for photo-sharing service Instagram in April 2012, with the rapid growth rate in users as likely to be the main reason behind the high price. It is also possible that Facebook was competing against Google for WhatsApp, as reports in April 2013 suggested that Google was prepared to offer US$1bn. Facebook may therefore have been forced to offer a higher offer to ensure it captured the platform instead of Google, indicating the value it places in WhatsApp. This is evident by comparing the price to that paid by Japanese e-commerce company Rakuten for a similar OTT chat service Viber, earlier in February 2014 equalling US$900mn.

Facebook Becoming A Mobile Oriented Company
Mobile Advertising As % Of Total Ad Revenue, 2012-2013

Why Did Facebook Acquire WhatsApp?

WhatsApp's explosive growth to over 450mn users has occurred in just four years, since the company was established in 2009. This rate is unprecedented, outperforming the likes of Facebook, Twitter, Gmail and Skype in each of their first four years of operations. While these other services are essentially free for users, WhatsApp charges US$0.99 a year to use, pointing to the inherent importance of the business model in replacing traditional SMS messaging services. It allows users to send as many messages as they like to friends and family anywhere in the world at no extra charge and offers group chat functions and photo sharing services. WhatsApp is believed to be particularly popular in North America, Europe, Latin America and other emerging markets. Its market penetration is thought to surpass 80% in mature markets such as Brazil, Germany, Portugal and Spain.

Following its initial public offering (IPO), many analysts feared the company had failed to monetise its mobile service, particularly as the first quarterly results were released. Facebook has since embarked on a strategy to turn itself into a 'mobile' company, recognising the importance and convenience of Facebook's mobile service as opposed to customers accessing it through a desktop. This is particularly true in emerging markets where many people access the internet exclusively through mobile phones, as it is more affordable and the 3G infrastructure more reliable than a fixed connection. BMI believes that the acquisition of WhatsApp fits with Facebook's desire to be seen as a mobile company, complementing its existing messenger service and enhancing the level of communication between its users.

Equally important, Facebook reported that it was seeing a decline in the number of teenage users and overall growth in monthly active users had slowed to 16% y-o-y in Q413. The company is reaching a level of saturation internationally, and bans on Western social networks in China exacerbate this problem. Youth customers are increasingly using services such as WhatsApp instead of Facebook's messaging service to stay in touch and the acquisition therefore removes a large competitor from the market. WhatsApp is the largest of the OTT messaging services in terms of its monthly active users (MAU), with Chinese rivals Weixin/ WeChat owned by Tencent reporting 271.9mn MAU in Q313. Of WhatsApp's 450mn MAU, 70% are active on a daily basis, higher than Facebook's 61.5% of total daily active users (DAU) in Q413, according to BMI calculations.

What Are The Risks?

Despite the strong reasons outlined above, Facebook's share price declined by around 2.2% in after hours trading, down from US$68.06 to US$66.55. In part, we attribute this to the large amount paid by Facebook for WhatsApp, given comparable deals such as Rakuten-Viber and Facebook-Instagram. The deal values each WhatsApp user at around US$42.22, while Rakuten paid just US$4.5. This has engendered suggestions of another 'bubble' in prices for start-up tech companies and the possibility of it eventually 'bursting'.

While WhatsApp has undoubtedly been a successful application so far, there is nothing wholly unique about the service, as many rivals offer similar platforms while providing extra functions as well, such as voice calling and e-commerce. This acquisition could therefore be seen as an example of Facebook buying growth, recognising its own service as reaching saturation and trying to inorganically boost this rate with acquisitions. Furthermore, many of WhatsApp's customers may already be Facebook users as well, as both are primarily popular in Western markets.

The biggest risk to the deal is how Facebook intends to monetise the service beyond the US$0.99 a year fee. Even with the 1bn users the company believes it can obtain, it will still take around 19 years in order to recoup this investment by which time trends in the telecoms and IT markets could make OTT obsolete. WhatsApp eschews advertising revenue and the acquisition announcement states that Facebook would not look to monetise the service with advertising and that it would still be run independently by WhatsApp.

A major concern among current WhatsApp users is the fear that Facebook will begin to collect customer data as it will have access to their mobile phone numbers. Data security has become a key issue following the NSA PRISM scandal and customers might decide to leave WhatsApp in favour of a more secure platform. This was highlighted by Facebook changing the terms of service following its purchase of Instagram, which was met with controversy and the exit of some users.

Price Drops By 2.2% In After-Hours Trading
Facebook Share Price, US$

The Future For Facebook-WhatsApp

BMI believes that there will not be any major changes to WhatsApp's business model in the short-term, as its new parent company will likely concern itself with growing the subscriber base to over 1bn users. Once it has been established as among the most dominant OTT messaging platforms, we expect pressure from shareholders to monetise the service will begin to mount and prove to be irresistible. In order to stave off the threat of competitive applications such as, WeChat, BlackBerry Messenger, Viber, Kakao Talk and Line, WhatsApp will look to introduce additional functionality, supporting services such as games, voice calling, e-commerce (such as sending virtual gifts) and other value-added services. It could then begin to charge a tiered rate for these additional services similar to Skype's premium service which allows group video chat, for example. Facebook's Q413 results show that 90.3% of its revenues came from advertising, so it may be difficult for the company to resist the temptation of introducing ads for WhatsApp. Collecting and selling data on messaging trends could also help boost sales, although such a move would be met with controversy. However, the purchase of Instagram by Facebook saw very little change to the platform in the first year or so and we expect the same to be true of WhatsApp.

For mobile operators around the world, the WhatsApp acquisition will raise further concern regarding the trend towards OTT messaging replacing traditional SMS. This is believed to be costing operators billions of dollars a year, as a valuable revenue stream is in decline. This is particularly true in developed markets, where the majority of subscribers use 3G or 4G technology through a smartphone and no longer use SMS to send messages or photos. With consolidated services of messaging, voice calls and sending photos, such as Facebook is aiming to provide, this will speed up the move towards OTT platforms and put increased pressure on mobile operator revenues.

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Related sectors of this article: Telecoms, Mobile
Geography: Global, Brazil, China, Germany, Spain, Portugal
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