Facebook Likes WhatsApp, but Should Shareholders?
The $19 billion cash/stock acquisition gives Facebook an entirely new revenue stream, but a lot has to go right in order to justify this deal's valuation, says Morningstar's Rick Summer.
Market Update
In a bold and aggressive move, Facebook (FB) has agreed to purchase WhatsApp, a global messaging company, for approximately $19 billion, including $4 billion in cash, 184 million shares of Facebook stock, and 46 million restricted stock units for employees of WhatsApp. Based on our fair value estimate, the size of the deal is roughly 13% of Facebook's enterprise value. The deal is expected to close in late 2014.
We are sticking with our fair value estimate for Facebook, and we maintain our wide economic moat rating. We still consider Facebook's shares to be overvalued, and we recommend investors to wait for a meaningful pullback in the stock price before allocating new capital to this name.
The deal's financial merits may eventually materialize. However, in our view, the potential synergies of this acquisition are at best opaque and potentially nonexistent. Facebook management has highlighted its intent to maintain WhatsApp as an independent product, with a nod to its Instagram acquisition. Furthermore, we think Facebook is unlikely to introduce advertising into WhatsApp messages, implying no potential increase in its ad revenue or monetization capabilities.
By acquiring WhatsApp, Facebook will now be managing three separate social networks: its eponymous Facebook platform, Instagram, and WhatsApp. While we think Instagram introduces additional scale for advertisers--which is a key component of Facebook's economic moat, in our assessment--WhatsApp does not deliver similar benefits.
WhatsApp counts more than 450 million monthly active users, with daily usage exceeding 70%, an impressive figure compared with Facebook's 62% daily engagement rate. WhatsApp CEO Jan Koum claims his company is adding more than 1 million registered users per day.
WhatsApp is largely being used as a replacement for traditional paid messaging services as an over-the-top application. In fact, its total messaging volume exceeds 19 billion messages per day, similar to worldwide SMS volume, according to the company. WhatsApp is currently free to users for the first year and $0.99 per year after that. Facebook has declined to share any information about conversion rates or customer churn.
The value of these OTT messaging applications is primarily based on a cost advantage versus traditional SMS messages--an advantage that we think is likely to be fleeting. We can't ignore the popularity of other messaging services, including Line, Kik, Skype, Viber, and WeChat, all of which count more than 100 million users each. Furthermore, we expect mobile operators to continue lowering costs and bundling messaging into data packages, eliminating some or all of the cost advantages of services like WhatsApp.
To the upside, the deal gives Facebook an entirely new revenue stream, and with it, myriad new opportunities to segment and charge customers. Additionally, we believe WhatsApp has been more successful in Europe and Latin America than it's been in the United States, and its acquisition could provide Facebook with an element of revenue diversification that might convey tax benefits. Still, at $19 billion (based on current stock prices), a lot has to go right in order to justify this deal's valuation, in our view.
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