The news last month that Facebook bought a messaging service for $19 billion drew immediate attention and renewed analysis of the Facebook business model. Most American investors had never even heard of WhatsApp, nor do they understand why it is worth more than the market capitalization of Xerox Corporation or Southwest Airlines.
So, let’s take a closer look at Facebook’s acquisition of WhatsApp, why it may actually be fairly valued, and what metrics Facebook investors should be keying in on.
With new companies in emerging industries, it’s worth looking closely at what is driving revenue growth. For the new social-media sector, analysts focus on "Number of Monthly Users." …
… a higher number of users tends to correlate with higher market cap and revenue. So, the question now is how well is Facebook doing in generating new users?
In 2012, Facebook monthly users increased by more than 17%. In 2013, growth of monthly users slowed to 11%. Even more troubling is that the more profitable U.S. and Canadian demographic only had a 3% increase in users in 2013, compared with 5.5% increase in 2012. …
… Facebook is having trouble generating new users organically, which helps explain the recent purchase of WhatsApp for $19 billion. WhatsApp is a messaging-service app, much like a text message, that allows users to send text, video, and pictures to each other without having to actually pay for a text messaging service. WhatsApp has also recently announced that it is adding a voice service as well, putting more pressure on telecom companies.
For those who have never heard of WhatsApp, keep in mind that it is not a huge player in the United States. It does, however, enjoy a large global presence outside the U.S., especially in emerging markets. WhatsApp is the most popular mobile-messaging app in emerging-market countries such as India, Brazil and Mexico. Even more impressive, WhatsApp dominates the market in Germany and Spain with 84% and 97% share, respectively. …
…WhatsApp currently has 465 million monthly active users — a number higher than LinkedIn, Twitter or Pandora. Even more remarkable, WhatsApp is gaining one million new users every day. At that breakneck pace, it would increase monthly users by more than 80% in 2014 alone.
The valuation seems to make sense when looking at its monthly users compared with Twitter and LinkedIn. Facebook is paying less for WhatsApp than the current market cap of LinkedIn and Twitter, yet it has more monthly users than either of them.
Does that mean Facebook is a buy? Typically, we would prefer to see growth generated organically vs. growth generated by acquisitions. However, at this stage in Facebook’s evolution, it may be just the right strategy. …
…The WhatsApp purchase allows Facebook to acquire a company that already has an impressive number of monthly users, and more importantly, a company that is growing their user base.
Remember that "ridiculous" $1 billion purchase of Instagram by Facebook two years ago — a company with no revenue and almost no name recognition at the time? Today, Instagram and its 150 million active users may be valued well above $10 billion.
At this point, we are not going to become Zucker-bears.