FB buying WhatsApp: By The Numbers

There was a storm of news coverage regarding FaceBook’s stunning announcement a few weeks ago regarding their acquisition of social media startup WhatsApp. Unfortunately, none of the stories made any serious attempt to analyze the financials or business logic behind the purchase. When one does take a moment to explore the available information in depth, however, the results are both paradoxical and illuminating.

Typical of the recent spate of internet startups in the San Francisco Bay area over the last half decade, WhatsApp is a tiny company with only 55 people on staff. The “value” of each employee from the purchase price works out to approximately $865M. This detail alone gives reasonable cause to doubt the sanity of FB’s executive team and directorial board.

Some have tried to explain away this exhorbitant price tag by focusing on the fact that “only” $4B of this is actual cash, while the remaining $15B is in the form of stock. Nonetheless, the stock portion has a cash value that could have been used either to acquire other assets or applied to other strategic initiatives such as new product R&D.

As an example: for $19B, FB could have bought Broadcom and had $1.5B in cash left over, or purchased both NVidia and Marvell Semiconductor together. These firms are well established, powerhouse technology companies with well developed customer bases and channels, as well as healthy financials.  Their technology-leading product portfolios consist of SoC (System on Chip) hardware and software for 3C (computing, communications & consumer) and mobile computing systems. From this simple comparison, one can immediately conclude that the widespread criticism and ridicule FB received for spending $19B to buy a 55-person social media startup remains exceedingly valid.

To be fair, a first order analysis suggests the acquisition may not appear to be completely stupid. WhatsApp claims to have about 450M users presently, with the user base growing by perhaps 1M/day. These users exchange 10B-20B text messages daily and have the ability to share video, audio and images, as well as conduct group chats.

The cost for these services varies widely. Downloading the app is generally free with annual costs ranging between $0 and $2, depending on where the user resides.

Though this suggests the possibility of an instant and potentially large revenue stream from the acquisition, a closer examination casts immediate doubt on such a possibility. WhatsApp does not currently support ads. Perhaps it could be recoded to do so, but the smartphone format has proven to be problematic for all advertisers – an issue with which not only the social media sector but the entire internet advertising industry is struggling.

Perhaps FB could expand the offering and drive up revenue potential by the provision of streaming media or some other attractive service with an increased (or at least reinforced) fee structure. The possibility of success in such an effort, on the other hand, becomes a dubious proposition once the composition of the user base is scrutinized more assiduously.

The proximally zero cost of WhatsApp has proven to be a nearly irresistible attraction to the third world. Apparently the overwhelming majority of current and new users are in underdeveloped countries. The appeal of the service stems from the ability to send texts in unlimited quantities for free.

From the viewpoint of these customers, WhatsApp is an incredibly cost effective way of staying in touch with family and friends worldwide. It becomes unnecessary for these customers to get on the internet, have a FB account or rely on any sophisticated access device such as a smartphone, tablet, laptop or desktop computer – items which are, in any event, mostly beyond the reach of such a user base.

These markets are served by bottom level cellphones that are offered with a very low cost yearly subscription plan – normally on the order of $25/yr. It is not uncommon to find WhatsApp already bundled with the offering.

This leads us to a financial analysis of the transaction. Keeping in mind that the overwhelming majority of the demographic does not have significant disposable income, let’s assume that FB finds a way to extract a steady $2/yr from every single individual in the customer base – both the existing users as well as the new ones added every day.

The first table shows the growth in WhatApp’s customer base, in millions of users:

2014	2015	2016	2017	2018	2019
450	450	450	450	450	450
365	365	365	365	365	365
	365	365	365	365	365
		365	365	365	365
			365	365	365
				365	365
					365
815	1180	1545	1910	2275	2640

The bottom number indicates the total number of users at the end of that calendar year. Assuming that none of the 450M current users or any of the future new users ever quits the application and the growth rate continues unabated, WhatApps’ customer base at the end of 2019 will, in theory, amount to 75% of the entire population of the third/underdeveloped world. 

Just for fun, let’s assume that this ridiculous number is achievable and that absolutely every single user – now and in the future – signs up for an enhanced bundle of services that costs $2/yr. The new users accumulated during a given year would deliver their full revenue potential only in the subsequent calendar year; therefore, the year in which they are signing up as fresh users naturally records an attenuated revenue collection. The resulting revenue stream would look something like this:

2014	2015	2016	2017	2018	2019
$900	$900	$900	$900	$900	$900
$365	$730	$730	$730	$730	$730
	$365	$730	$730	$730	$730
		$365	$730	$730	$730
			$365	$730	$730
				$365	$730
					$365
$1,265	$1,995	$2,725	$3,455	$4,185	$4,915

Summing the cumulative revenues from 2014 thru 2019 results in a total of $18.54B. Thus, given all of the above decidedly optimistic assumptions, FB will have to wait for a bit more than six years before they can expect to simply break even on the acquisition.

There is an additional wrinkle to this analysis which bears consideration. All these new users sending and receiving huge quantities of data thru text, video and audio - as well as whatever additional services FB bolts in so as to ensure that they can collect $2/yr from every WhatsApp user - will need bandwidth to support their activity. This will place enormous pressure on the regional cellphone service providers to expand their PPE (Property, Plant and Equipment.) Who is going to pay for this? Will the providers revolt and demand that Facebook share its WhatsApp revenues with them?

All of these factors cannot but help to give Facebook shareholders and market observers pause. At the moment, the only clear winner in this transaction is, most likely, the NSA. Despite heated denials and obfuscation, the cooperative relationship between Facebook and the US signals intelligence agency is at this point widely known. One could imagine NSA executive directors being keenly interested in monitoring the text and multimedia exchanges occurring in the underdeveloped world. Perhaps the NSA is providing financial compensation to FB for its cooperation in such matters, which would go a long way towards explaining the seeming ease with which FB parted with $19B in cash and stock.

Does FB know something that we don’t know? Perhaps. Do they have a method of collecting significantly more subscription revenue from users? Maybe. But until FB becomes much more expansive about its motivations, cost justifications, overall strategy and plans regarding WhatsApp, the wisdom of the acquisition will remain questionable with much of the public, as well as the internet and financial communities.

The author would like to thank the following people for their insights, contributions and critiques on this topic:

Abhijit Athavale – Markonix

Chris Demetrakos – Manzanita LLP