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The irrational rationality behind Facebook’s $16 billion acquisition of WhatsApp

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Another day and another acquisition — and another one that is jaw dropping and seemingly insane.

Less than a week after Japan’s Rakuten acquired Viber for $900 million, Facebook co-founder and chief executive Mark Zuckerberg announced that he is buying WhatsApp for a whopping $16 billion in cash and stock. Add another $3 billion for WhatsApp employees may get over next few years in restricted stock, and this becomes a $19 billion company.

When I think about the deal, it actually makes what investor Paul Kedrosky calls “ridiculously rational” sense. It keeps WhatsApp out of the hands of Google and most importantly takes out an aggressive competitor for “attention” from the market.

Facebook is going to end up competing with apps like Line and WeChat in many markets for the consumer’s mobile minutes and WhatsApp gives the Menlo Park based company a strong competitive weapon. While potential monetization remains a bit of a head scratcher, there are more options for the company to think about, like new native advertisements in the near future. WhatsApp as an app store is not out of the realm; I said so as part of a roundtable hosted by Bloomberg West’s Emily Chang.

Images courtesy from Facebook messenger (L) and WhatsApp (R).
Images courtesy from Facebook messenger (L) and Whatsapp (R).

The deal makes (weird) sense especially if you view it from a historical lens. There are three such deals that have occurred in the past: Microsoft bought Hotmail in 1997 for $400 million and the reaction was, are they crazy? It allowed Microsoft to get to webscale really fast at a time when email was important as synchronous communication is today. It would be safe to say Microsoft did fine on that acquisition.

AOL, or America Online as it was known as then, acquired ICQ, another fast growing instant messaging network, for $400 million. Aol had its own IM network and whether it was hubris or corporate politics, it ruined ICQ and limited its own potential to control the IM market. Microsoft used the Hotmail community to jump start its IM efforts.

Another company that acquired a fast-growing communications platform was eBay, which bought Skype. There was no synergy in that deal and it wasn’t a surprise that it failed. Skype is now a part of Microsoft. Microsoft bought Skype in 2011 for a whopping $8.5 billion but has managed to muck up the deal.

Skype was ahead of the curve in terms of synchronous communications — textual and visual. A residency at Microsoft has been its undoing.

Now compare these with WhatsApp and Facebook. Both companies are in the same business — connecting people through communication. But their methods of communication — or modalities of communication — are different. WhatsApp is synchronous and has a different kind of immediacy, while Facebook’s atomic unit of communication is personal status updates with the intention of interacting with people you already know.

Facebook has had a tough time trying to invent new native behaviors, mostly because it has a powerful basic unit of communication and interaction. WhatsApp brings some unique capabilities, much like Instagram, which brought a different set of interaction attributes.

Over next few days you are going to hear that this deal is bad for Snapchat or Twitter and it is simply not true. They have different communication behaviors attached to them and Facebook and WhatsApp are not those applications.

Another bit of historical perspective — Cisco used to make aggressive acquisitions using its inflated stock market capitalization in order to stave off competitors who threatened its core business and move into parallel markets. Zuckerberg, too, is an aggressive CEO who knows that falling prey to “not invented here” philosophy is sure way to fall behind.

Most importantly — he knows if an app or service can get to a billion users, then it can do what he fears the most — take attention away from Facebook.

45 Responses to “The irrational rationality behind Facebook’s $16 billion acquisition of WhatsApp”

  1. Harry Callahan

    Uh, what? Ebay made money on Skype. Ebay paid $2.5 billion for Skype in 2007. In 2009, they sold 65% of Skype to Silver Lake for $1.9 billion. In 2011, Microsoft bought all of Skype for $8.5 billion; at this point, eBay still owned 35% of Skype, for which they received $3.0 billion. Their Skype “failure” netted them almost $2.4 billion dollars profit. While eBay failed to do anything useful with Skype’s business operations, they made a ton of money on the deal.

  2. fredhstein

    Valuation: Zuckerberg is thinking about 1B users, where they will be soon enough, or about $20 / user. Many users live in developing countries, so monetization will take time. FB are paying partly with stock, which dilutes the stock by about 5.5%. Curious how investors respond once this is factored in.

    Another example of a pricey acquisition was YouTube by Google. Most agree this has paid off.

  3. amusedinil

    Let’s just remember: WhatsApp is not Autonomy. HP HAD to have Autonomy, and at $8B, it’s looking like a better deal, now that it can be compared with this valuation.

  4. Maybe I’m just a simple country bumpkin, but despite WhatsApp having tons of traffic, are they making any money? How are their financials? $18 billion seems like a lot, especially when compared to MS buying Skype. Perhaps I just don’t get it…

  5. Om, you’re doing it to me, again. My wife and I have been discussing Paul Kedrosky’s analysis of the purchase after seeing him on Tom Keene’s show on Bloomberg, this morning.

    I turn on the iMac and wander into GigaOm to see what the topics are, this morning – and here you are covering Kedrosky’s analysis 12 hours ago.

    When do you ever sleep?

  6. agree with thesis. ntm this deal is comparable to google’s buyout of youtube, same $ per user. Then vs. now, I daresay What’s users are more valuable then Youtube’s

  7. Mukta Arankalle Aphale

    Absolutely true. I am amongst the 450 million users of WhatsApp, who had started preferring whatsapp mode of communication to the FB mode. Reason: I can send messages only to that group of people for whom the message is intended! FB for me had become like a public profile, where I post stuff only for the generic public to know that I exist :)
    Am sure many users had just begun to prefer whatsapp, when Zuckerberg made the right move!

  8. Anurag Bhatia

    Nice article Om. Apart from focusing on social media trends, we have to understand how things are turning around on network layer. Over time IP based technologies are going to take over traditional models along with relatively deep penetration of Wifi in urban areas. Thus a combination of this trend + whatsapp + wifi – gives significant power to company like Facebook to have heavy control on the communication world. If they didn’t went for that then they would still have users in future relying on incumbent operator.

    I am not a Facebook user nor I understand the whopping price Facebook is paying but at the end I am happy to see such high evaluation which clearly shows we will very soon have operators operating “dumb pipe”.


  9. Himanshu Mody

    In India where the the smart phone penetration is increasing at insane pace. If I assess say 30 people I am acquainted to who are NOT digitally savvy , irrespective of age, sex, education. They mostly do not use Facebook , but every one is on What’s app and uses it extensively. Facebook represents the outer circle of a person. I think most of us do not interact with people in our inner circle on FB. But we do that on Whats’app – the next plan of holiday, sending out invites or reminders or plannning for a weekend etc. So all though there will be a huge common user base between FB and What’s app. This acquisition takes FB a level deeper. Something FB could never do on its own.

  10. J Nicholas Gross

    “Both companies are in the same business — connecting people through communication.”

    That’s a poor comparison – if you want to dilute FB’s down to a single function, you might as well say they both “do business on the Internet.” Unlike Whatsapp, FB is an entire ecosystem that draws people in for an experience. The former is just a primitive communications tool, and, in fact, just one of many such tools.

    • Bill Richards

      Whatsapp does everything users use Facebook for an more. Do you use Whatsapp? It more advanced than Facebook.

      Not only does it have more features but Whatsapp is already sharing more photos daily than Facebook.

      Facebook is buying up its #1 competition because it is scared and that is smart of Facebook.

      Personally I think this merger should be blocked on anti-trust grounds.

      Consumers are getting hurt by losing the major option to not using Facebook. Facebook will mine your data. I dont want Facebook tracking my life.

  11. The rational for buying them makes perfect sense. The question is did they pay way too much?

    You could say once a communications service like this gains critical mass then a moat is built around it that would be hard to break. IT becomes what everyone uses and you can’t just use something else if no one else is using it. Look no farther than Google+ vs Facebook.

    On the other hand it’s just a piece of software. And from the sound of it not a very unique piece of software. I doubt you can ever really monetize something like this because the competition can easily provide the same thing for free or next to free and computing resources just keep getting cheaper over time. Can Facebook ever earn a decent return on this investment?

    Next who says customers don’t wake up in a few years and decide to use something else. That’s the other problem with investing so much in something like this.

  12. Amit Jain

    What amazed me was the speed? Zukerberg says they took 11 days from start to finish. I think only OM’s speed in posting this quick and useful viewpoint was faster :-)

    – Does it make deals for others imminent? With Whatsapp and Viber gone, I think Google really would be keen to snare one of the other meaningful players? I dont think Microsoft will have the appetite to make a move in this space with Skype still a work in progress. And the game is still not over I think because none of the mobile messaging apps dominate across the globe yet. Ofcourse whatsapp’s global march should accelerate now.

    – The whatsapp team has said that they will continue to run it independently. But will we see no product integration at all? Will need to be carefully thought thru. A lot of young users have moved on to messaging apps with one of the key reasons being that these apps offer far more privacy compared to the very public nature of activities on facebook with every one from parents, uncles and grandparents there.

    – if its not going to be advertising, but subscription and overlaid services which whatsapp will use to monetize, which services might find most traction. I believe there could be a lot of traction here around building a p2p payment ecosystem on top of it – payments inherently implies exchange and all the circle of people with whom i may need to exchange money viz. my friends / biz network is already there on the app – why not push money just like you push messages? ofcourse payments is an inherently regulated industry with every country having its own set of rules.

  13. Dhivik A Reddy

    Search a little more on the internet I might find a post which says “Smoking is good for health”.
    Overpriced deal even if the acquisition was in credit to data mine !

  14. Only 5 years from now will this become a good or bad decision. If the ‘bubble’ bursts this will be the poster child for that.. if FB does well then it will be a very wise decision by a young CEO.. history is always written by the winner. At this point, all we can do is wait and watch someone going all-in in a poker game..

  15. How can you call eBay’s purchase of Skype a bad deal?

    They paid $2.6B, sold for$8.5B and Skype was profitable every year, but 2006. Sure, it didn’t change eBay, but I would quite happy for an almost 300% return on my investment.

    Have we become so skewed that success is only measured in ridiculous over-valuations like FB’s purchase today? I mean c’mon. Skype wasn’t just generating revenue, it was profitable and Microsoft paid a lot less.

    • WhatsApp is also profitable and much more than Skype will ever be. With $1 user/year the cashflow is there. When they get to a billion users (in the 12-15 months assuming constant growth) that’s another billion/year… just from the user base…

      • Apparently their revenue last year is rumored at $20 Million. All those users are not paying. They get the first year free, and I’ve seen many people saying they’ve been using it for more than a year without paying. At $1 year, even if most people are paying (they’re not) – it would take 42 years to break even assuming zero cost of revenue (impossible).

  16. hear that this deal is bad for Snapchat or Twitter and it is simply not true. They have different communication behaviors attached to them and Facebook and WhatsApp are not those applications.

    Hmmmm. The question is not communication mode, but rather attention time, which is finite. This is going to be a near zero sum game.

    As for the deal price, FB is giving up 10% of its capitalization, and 5 years of OCF. This is to prevent larger losses if a competitor had bought the company? There will have to be a lot of earnings attached to the acquisition to make financial sense. This looks like a bubble to me.

  17. Om, interesting discussion but I still don’t see your logic.

    At $19 billion, Facebook is paying over $42 for each of WhatsApp’s 450 million users, most of which live in developing countries. Especially if Facebook will leave the company as an independent subsidiary without ads, I don’t see how it makes sense to pat $42 per customer, especially with their customer profile.

    Buying the company to avoid distractions is ridiculous at $19B. It sounds more like a desperate move to claim an additional half-billion users and sustain valuation until advertising revenue picks up. Very few marketers have success stories of Facebook marketing, the ROI is just not there. If you look at SuperBowl ads, unlike last year’s, most did not provide a Facebook URL.

    I guess time will tell who is right.

    • Dude as soon as I get a whiff of Zuckerbergs FB shit on WhatsApp I am gone! I embraced them because it avoided the big guys and homogenized the process.

      Since the NSA owns Google and FB I may have to turn my back on Whatsapp anyway and its a damn shame.

    • The assumption is obviously that the user base will continue to grow at a its break neck pace. Facebook ought to be able to actually increase the adoption rate of the app with its current resources (not to mention it is on the front of every newspaper and website across the world). It really only takes 1 app embedded in a phone receiving location, usage, phone type, among other things to make that user much more valuable to an advertiser. The fact that their customer profile is not what you expect may mean that it is a more valuable bucket of users because they are less likely to have other facebook owned apps embedded in their phones. Superbowl ads are on the opposite side of the spectrum of advanced and highly targeted advertising directed directly to a mobile phone. Although it is hard to spend lots of money on high target advertising currently because of the difficulty in structuring queries and because there isnt enough inventory to allow for a lot of highly targeted inventory (as it will by definition be a small part of total inventory). This acquisition ads greatly to FBs inventory and also keeps others from having it. I do not think it is as much about time share or mind share and actually more about phone and person share than people may be realizing.

  18. mikey b. ledesma

    I say who cares…I loved when Silicon Valley old buisness people said go outside and play with friends and be active in sports and activities. I seen other areas of the world still growing up to this day like I did without media and are better off. America eats fastfood and sits in front of the T.V. and computer. People are on thier phones constantly even with friends in the room as well as in the car driveing. Im American born and bred. I say enoughs enough. Bet you want to sit there high on pot and be like…OH WELL. NO JOBS. PEOPLE EVERWHERE ELSE HAVE THEM. LET A COMPUTER RUN EVERYTHING. LIKE SOMETHING AND BE POLLED AS WELL AS MONITERED IN SECRET. WAKE UP.

  19. So what number would of been too much to pay? 20 bil? 30 bil? 50 bil??
    14 billion is a lot to pay. Sure, the inflated stock price made it the right time to do it. But this deal shows one thing. The companies that are in the business of “connecting people” are showing their cards…. Our data is worth a lot of money. I think it’s more about tapping into data collection as a valuable asset to AI.

  20. Schtaunkhauser

    Ummm….. can’t believe you didn’t mention that the CIA owns a part of Facebook, and much like Skype, wants Whatsapp in US hands.

    No problem say the Libertarians – we’ll use Cryptocat! Except Cryptocat was turned down in the App store……