Facebook's (NASDAQ:FB) announcement that it is spending $19 billion (including the value of common shares and restricted stock units for employee compensation) to acquire the multi-platform messaging service WhatsApp took everyone by surprise. $19 billion for a 55-employee company? The notion seemed crazy.
But Facebook wasn't the only company making multibillion-dollar offers for the app. Google's CEO Larry Page was willing to actually pay more than $19 billion for the company, according to The Information authors Amir Efrati and Jessica Lessin. WhatsApp wasn't interested in Google's pitch, however, because it was framed as if the only purpose was to keep WhatsApp away from Facebook, according to Efrati and Lessin. Apparently, WhatsApp is a hot commodity among tech giants.
But where's all this excitement coming from? Why is this app so important? More specifically, why is it worth so much?
Reviewing the app's business model, it's clear there is money in the messaging business -- but it's going to have to ramp things up to justify a $19 billion valuation.
The current WhatsApp business model looks like this.
WhatsApp despises ads and has vowed to never have any on the app. Instead, the company opts to allow members to use the service free for the first year and pay a nominal fee of $1 per year thereafter. With both a massive user base of 465 million monthly active users and a trajectory to reach 1 billion within a few years, even $1 dollar per user can add up. But enough to merit Facebook's borderline euphoric outlook for the service?
Over the weekend, The Wall Street Journal's Dennis Berman set out to uncover the answer. Here are the numbers he came up with.
Sixty percent. That's the operating margin Berman estimates WhatsApp runs its business at. Berman notes that is about twice the operating margin telecom behemoth Verizon Wireless reports. With a robust operating margin of 60%, on top of a very compelling value proposition for users, WhatsApp has the potential to be a sustainable cash cow.
Two billion. WhatsApp co-founder and CEO Jan Koum believes the app could eventually reach as many as 2 billion people -- up from its half-billion user base today. Considering that the app is only free during the first year, that's an ambitious goal. Many third-world citizens won't be so excited about even $1 per year.
But if he's right, a number like this, combined with robust operating margins, can help move the needle on Facebook's bottom line -- albeit only slightly with Facebook reporting a whopping $1.13 billion in net income from operations in the fourth quarter alone.
Two dollars and eighty-four cents. That's the amount per user, at 1 billion users, Facebook would need to collect in operating profits to have the WhatsApp valuation be comparable to the price Verizon paid to buy Vodafone Group PLC's 45% stake in their joint venture. That's a big stretch, but it's at least imaginable.
Does the valuation make sense?
By taking a look at some chewable numbers, Berman doesn't necessarily justify Facebook's valuation of WhatsApp, but he does make the valuation seem more reasonable. Berman says the numbers have helped him upgrade his thoughts on Facebook's valuation of WhatsApp from downright crazy to "crazy-ish."
But looking at these numbers combined with the fact that Facebook is playing defense by acquiring the world's fastest growing social platform, I think I can finally say that I'm happy with Facebook's WhatsApp purchase.
Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of Facebook and Google. 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.