Apparently, Facebook (NASDAQ:FB) offered to buy Snapchat for $3 billion in cash and was rejected, according to The Wall Street Journal.
For those unaware, Snapchat's entire social experience is based on sharing photo and video clips that only can be viewed for a maximum of 10 seconds before being permanently deleted. It's very popular with teenagers, and the service hasn't earned any revenue.
What on earth was Facebook thinking?
Signs of desperation
My gut reaction is that Facebook is completely desperate for teenage engagement, because this alleged deal comes hot off of Facebook's earnings report, which acknowledged for the first time that daily usage among U.S. young teenagers declined sequentially. But before I acknowledge my gut, let's think about Facebook's previous behavior.
When Facebook purchased Instagram in April 2012 for $1 billion, the photo-sharing network had only 30 million monthly active users, or MAUs, and earned no revenue; the deal looked like a complete flop. Fast-forward to today, and Instagram has begun monetizing its user base, which has grown to over 150 million MAUs. Sure, Snapchat for $3 billion sounds like complete madness today; but $3 billion today could potentially be worth a lot more tomorrow.
Crunching the numbers
Snapchat doesn't report MAUs, but it did report in September that 350 million "snaps" are shared daily between users. To arrive at Snapchat's MAU base, we have to make some sort of assumption about the average number of daily "snaps" shared per user. A recent Pew Research survey suggests that Snapchat has 26 million MAUs, which breaks down to about 13.5 daily snaps per MAU, which I don't think is unreasonable, considering the average 18 to 24 year old sends 67 text messages a day.
Now, if we take Facebook's advertising revenue per mobile user of $1.01 last quarter, and apply it to Pew's MAU estimate, we're talking about roughly $105 million in annual revenue. The billion-dollar question is the premium Facebook is willing to pay for an in-demand service. Considering Facebook shares currently trade at 17.4 times its annual revenues, which is low for social networking companies, I'd be willing to wager that Snapchat would command a premium to this figure.
But even at 17.4 times annual revenue, we're talking about a more than $1.8 billion valuation. At these multiples, $3 billion doesn't seem that far off the mark, especially after accounting for the likelihood that Snapchat will continue attracting users in the short term, and Facebook will need to pay a hefty premium.
Of course, Snapchat going from zero to its full potential isn't going to happen overnight, and it isn't even a guarantee that Snapchat could ever reach this potential, given the fickle nature of teens. To make matters more challenging, Facebook will likely have to invent a new ad format that plays into Snapchat's strengths, like an ad format that vanishes in five seconds or less.
Not that crazy?
If there's one company that can turn an unproven business into a proven one, it's Facebook. Let's not forget that Facebook turned the "threat" of mobile cannibalizing its desktop ad business into a massive revenue center. Nowadays, Facebook's mobile revenue has grown to make up 49% of its ad revenue. The bottom line is that Facebook is a creative and highly adaptable business. For $3 billion, it's pretty clear that Facebook sees a lot potential here -- but it's even clearer that Snapchat sees more.
Fool contributor Steve Heller owns shares of Facebook. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.