Yes, WhatsApp was Overpriced

From today’s WSJ: A nice article about the mathematics behind Facebook’s $19 billion purchase of WhatsApp.

Where the author, in attempting to use some math (remember, math is hard) has this to say (comparing Verizon’s purchase of its joint venture, a deal in which it paid Vodafone $130 billion):

So what would happen if we benchmarked revenueless WhatsApp against this gold standard of telecom deal-making? What would it take to give those WhatsApp customers some of the traits of the Verizon ones? In essence, how would we reverse-engineer a crazy deal into a noncrazy one?

At first, the numbers look as stark as you’d expect. We know that Facebook paid $42 for each of WhatsApp’s 450 million users. Verizon, by comparison, valued each of its roughly 97 million monthly contract connections at about $2,984.

Verizon collected about $669 for each of these post-paid connections last year, and made another $168 per subscriber from other sources.

What did WhatsApp collect for its service, which allows for unlimited and quick text messaging? What a pesky question. Basically zero. For math’s sake, let’s take the figure to 50 cents per user in 2014.

This helps us get a slightly cleaner apples-to-apples comparison between the companies. That is what Wall Street calls a “multiple”—what each company is willing to pay for each dollar of revenue. By that measure, Verizon paid 3.5 times revenue per subscriber, and Facebook, hypothetically, 84 times. Still kind of crazy, right?

Wait a minute?  It’s a pesky question so let’s go ahead and make up an answer that is not only wrong, but off by an order of magnitude?  Actually, WhatApp had revenues of $0.044 for each “user”.  Not $0.50.  That’s a huge difference when there are 450 million “users”.  Additionally, (and hence my quotes) “users” are not customers.  They don’t all pay, and many of them never will.  Why pay for something that is now free, and why pay for something you can buy through your wireless carrier?  If wireless carriers ever feel competitive pressure from WhatsApp they will just reprice their product and BOOM!, competitive advantage gone…

No one knows what WhatsApp’s operating margins are. The indications are that the company turned a profit on its rumored $20 million in revenue. This we do know: It has about 50 employees—the staff of a decent-sized Verizon store. It has no marketing costs. No Washington lobbyists. No cell towers. No stores. No global campus. No sponsorship of the local symphony.

Arguably its single biggest expense is the 30% it pays Apple and Google to distribute its app. There are surely storage and bandwidth costs as its customer base grows. And keeping the software fresh requires some engineering talent.

But beyond that? We’ll have to take a guess and peg WhatsApp’s operating margins at roughly double Verizon, or 60%. New access to Facebook’s servers and engineering talent should only improve that figure.

How is it possible that their operating margins are 60 percent?  Think about that:

$20 million in revenues – 30% to Google and Apple.  That leaves $14 million to pay server expenses, salaries, bonuses, space (admittedly small) and overhead.  The claim that they have 60 percent operating margins essentially says they spend $2 million on salaries for 50 employees PLUS other operating expenses (operating income equals total revenue – cost of goods sold – other operating expenses, i.e. wages, – depreciation)?  I don’t think so.

More likely, their operating margins are similar to Verizon’s, but the total revenues from each “user” are tiny compared to Verizon’s.  This is not to say that it isn’t possible to create significant value from WhatsApp’s user base, or to develop a new line of business.  But Skype (revenues of $2 billion) has been trying it for years and still struggles somewhat to find the “right” niche (which may be because it is owned by Microsoft, which hasn’t had an original thought in a decade).

Don’t get caught up in the numbers of the purchase, but don’t make them up either.  I’m just glad I am not invested in Facebook, because that type of leadership is not good for investors.