Earlier this month, The Wall Street Journal published a bombshell report that extensively detailed the falling out between Facebook (FB +1.81%) and WhatsApp. There was an irreconcilable culture clash between the two companies, as WhatsApp was initially built with strong privacy controls and a fundamental disdain -- nay, loathing -- for ads.
WhatsApp was supposed to be able to retain its autonomy following the acquisition, but in the years since, the tension and pressure to monetize only grew, culminating in both WhatsApp founders leaving the company within the past year; co-founder Jan Koum announced his resignation just last month.
There are a few specific details in the report that are worth dissecting a bit further.
Image source: WhatsApp.
Facebook's top two execs are getting "impatient"
Citing sources, the report says CEO Mark Zuckerberg and COO Sheryl Sandberg "pushed the WhatsApp founders to be more flexible on [how to monetize WhatsApp] and move faster on other plans to generate revenue," in part because the duo "grew impatient for a greater return" on the $22 billion acquisition. It remains Facebook's largest acquisition to date by a factor of nearly 10.
Curiously, the report states that WhatsApp was profitable at the time of acquisition, when it had a simple (and incredibly cheap) subscription plan that cost a mere $1 per year. However, this is not accurate. While Facebook does not currently disclose WhatsApp financials, it provided a one-time glimpse of WhatsApp's books (in SEC filings here and here), which showed that the messaging service had generated trailing-12-month (TTM) revenue of $22.7 million and a TTM net loss of $311.9 million at the time of acquisition.
Here's a brief overview of WhatsApp's income statement for 2012, 2013, and the first half of 2014:
|
Income Statement Metric |
2012 |
2013 |
1H'14 |
|---|---|---|---|
|
Revenue |
$3.8 million |
$10.2 million |
$15.3 million |
|
Total costs and expenses |
$59.4 million |
$148.7 million |
$247.6 million |
|
Operating loss |
($55.6 million) |
($138.5 million) |
($232.3 million) |
|
Net loss |
($54.7 million) |
($138.1 million) |
($232.5 million) |
Data source: SEC filings.
If you're thinking these financials don't look like a company worth $22 billion, I'd agree wholeheartedly. It's been over four years since the deal was announced, and I still think Facebook overpaid.
Tick, tock
More specifically, the direct result of paying such a massive premium for such a small company is that Facebook recorded an incredible amount of goodwill and intangible assets on its balance sheet tied to the acquisition. Some of the intangibles have been amortized in the years since, but that goodwill is still sitting there, waiting to potentially be impaired and written down if the acquisition fails to prove its worth.
FB Goodwill and Intangibles (Quarterly) data by YCharts.
I still consider that goodwill to be a potential time bomb.
The plot thickens
There's another aspect to consider here. In January 2017, the Financial Accounting Standards Board (FASB), which is the organization that sets GAAP accounting standards in the U.S., announced that it would be simplifying the test for goodwill impairment by eliminating the second step. The change is intended to reduce the time and costs associated with the process.
The nitty-gritty details are beyond the scope of this article, but PricewaterhouseCoopers, one of the big four accounting and auditing firms, notes: "The increased efficiency may result in a reduction in precision, but many users have indicated that the more useful information is knowing whether an impairment charge is warranted, not necessarily the precise amount." Under the simpler process, an impairment could be caused by other assets within the reporting unit (WhatsApp).
Public companies are required to adopt the new testing process in fiscal years starting after Dec. 15, 2019 -- about a year and a half from now. For what it's worth, Facebook acknowledges the upcoming change in its 10-K and plans to adopt the new method in the first quarter of 2020 and does "not expect the standard to have a material impact on our consolidated financial statements."
In other words, determining whether Facebook needs to eat a goodwill impairment is about to get easier. Building businesses takes time, and the longer it takes, the greater the potential risk that Facebook will need to recognize an impairment charge.
An impairment would be a massive embarrassment
All of these angles combined could perhaps help explain why His Zuckness and Sandberg are under pressure to monetize WhatsApp: In order to avoid a huge write-off that would not only cost shareholders billions of dollars in evaporated value, but also tarnish Zuck's reputation as a visionary leader willing to scoop up burgeoning social media platforms at any cost in his quest to build an empire.
