Wednesday, February 19, 2014

Facebook Buys Whatsapp - The Reasons: What was Zuck thinking?

Facebook has acquired WhatsApp for an eye popping USD 19 billion dollars. In INR terms that is Rs 1,18,370 Crore. The whopping acquisition price includes USD 4 billion in cash, about USD 12 billion worth of Facebook shares and USD 3 billion in restricted stock units to be granted to WhatsApp’s founders and employees that will vest over four years following the closing of the deal. Happiness here, but many of Facebook's shareholders were not happy, punishing the stock which ended down post the announcement. So the big questions is: What was Zuckerberg thinking?
Here are my thoughts:
  • Whatsapp has 450 million people and adding 1 million people every day. With a little push WhatsApp can reach a billion plus people or more, same as Facebook.
  • Facebook believes its future is on the mobile phones. WhatsApp has become a part of life for smart phone users worldwide and many of these use WhatsApp much more than facebook.
  • While Facebook is all about sharing and putting your life for everyone to see and people may stop using facebook if this trend reverses . Messaging on WhatsApp satisfies peoples need to share  and communicate and at the same time gives them an option to feel much more secure.
  • WhatsApp is a simple, fast and reliable mobile messaging service, and in these aspects it is a lot better than facebook.
  • You don't have to join facebook, or remain on facebook to keep using WhatsApp. So Facebook is hedging its bets
Investors, however, are worried that this dilutes Facebook's earnings. At $173 billion market cap, facebook is already valued over a 100 times its net earnings. 
However, Zuck is using one expensive currency to buy another asset so in reality, he is not paying as much at least in practice even if he is paying more in theory. Importantly for Zuck and for all those whose primary investment is in Facebook this diversifies their portfolio. Adding WhatsApp is therefore much more cheaper for Zuck than for an ordinary, marginal investors like private equity and hedge funds.
Then there is the questions of whether incremental money is important to Zuckerberg or not. Studies point to decreasing utility and psychological effects of money as it increases. Zuck is probably more motivated by his initiative and the power he enjoys, by virtue of being able to connect billions of users. 
Now, ordinarily minority shareholders would protest and Zuck may have had to back off. But, remember Zuck controls most of the voting rights.

While some creative and complex arguments can be made to justify the valuation, in the long term the ultimate value is cash flows which WhatsApp seems to lack at the moment.

Anyways, here are some interesting questions that a FB investor must consider:

  1. Build vs Buy: Traditional M&A takes into account build vs buy. However how do you value an acquisition where you have failed to build, even though estimated cost to build may be much lower.
  2.  Need to achieve diversification, especially when there have been doubts raised about sustainability of the business.
  3.  Need to signal that you believe in the valuation that your own company is getting
  4.  If you are worth close to 50 billion dollars, a few billion dollars up or down does not matter vs the marginal investor
  5.  Since FB has been doing well, no body yet has questioned governance and minority rights at FB. Remember Zuck has disproportionate voting rights. How does an investor view this or is that part of the deal.
  6.  How do you value a competitor which can hurt or is already hurting your cash flows, even if it does not create cash flows of its own?

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