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Why You Should Watch Facebook Closely

By Renjit Ebroo – Mar 3, 2014 at 10:15PM

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Facebook made the headlines by announcing that it was buying WhatsApp in a deal worth about $19 billion. Might this be the beginning of a bull run on Facebook?

Many reasons have been given to justify or criticize Facebook's (META 1.97%) purchase of WhatsApp. Most of them seem to revolve around the price. The purchase is bound to break some records. For comparison, Google (GOOGL 2.81%) bought Motorola's handset business for about $12.5 billion. Are apps now hotter than the phones on which they run? At this point, that's not entirely clear. But what is clear is WhatsApp has a large user base and is growing faster than Facebook did at the same stage of its existence.

WhatsApp provides another model of social networking that is gaining popularity: private, fast, and impermanent communication. That's not all. It also provides a much cheaper alternative to Short Messaging Service, SMS, which is popular with users of mobile phones. For many users, it's probably already an alternative to Facebook's own messaging system.

Is Facebook vulnerable?
When Facebook bought Instagram for $1 billion, it was perhaps a tacit admission that disruption can come from the fringes. The purchase of WhatsApp can also be seen this way. The buying pattern exposes a key threat that Facebook and other social networks face: The disruption of components that make up the whole, by new apps with razor-like focus. Unlike changing a computer operating system, the switching costs for users can be minimal.

Technology has common roots with the word technique. New techniques are constantly being developed for practically everything, from nuclear reactors to tin openers. Not excluded are social networks like Facebook and Twitter (TWTR). The potential to be disrupted by new technology (or even old technology packaged in a new way) is a vulnerability that all businesses have. It can happen quite fast for a technology company.

When new techniques become popular, established techniques and entire companies may disappear. Instagram's video service was one such attempt by Facebook. Already, messaging apps like WhatsApp have set the stage for decreased SMS usage. 

Caution: social network ahead
Currently, other social networks are popular. Maybe diversity describes their fortunes as much as their target audiences. For example, LinkedIn (LNKD.DL) is a growing and profitable network. It targets professionals and organizations based on at least two recurring needs: new jobs and new employees. Twitter, on the other hand, dominates a part of the market that could be described loosely as news and commentary. Unfortunately, it has not shown a sustained ability to generate profits, but revenue growth is impressive. Seven years from inception, Twitter's 2013 revenue was almost $700 million.

This is the anomaly about many social networks: incredibly large user bases but monetization that seems out of step with investor expectations. An example is YouTube which is estimated to have close to 1 billion users monthly. While Google provides no separate financial figures, YouTube was estimated to have generated about $4 billion in revenue in 2013. This came in the eighth year of YouTube's existence. It is safe to say that in social networking not all products can be monetized in the same way.

So the purchase of WhatsApp could be a gamble for Facebook.

Perhaps Facebook is up to something else
However, this story may not end in gloom. There are a few signs that could indicate something big. First, the CEOs of both Facebook and WhatsApp attended the Mobile World Congress in Barcelona. WhatsApp made another announcement that it will soon introduce voice calling. Also significant, Facebook's CEO is said to have had a meeting with executives from the telecom industry during his Barcelona trip.

In the past, rumors have regularly surfaced about a Facebook phone. With WhatsApp, however, the opportunity could open up for Facebook to disrupt a different industry: telecom. If voice calling is added to WhatsApp, a smartphone may not need voice and SMS services from a wireless carrier.

Unconnected to Facebook, Mozilla showcased smartphones running the Firefox operating system in Barcelona. It claims the phones could be sold for as low as $25. With speculation that the high end of the smartphone market is saturated, the opportunity for cheap smartphones may exist. Undoubtedly manufacturers are seeking avenues for growth. In any case, cheap smartphones and the number of mobile phone subscriptions almost nearing the world's population could mean one thing for Facebook: a new billion-dollar business if it can tackle the opportunity. With some design tweaks, perhaps even smart watches could run WhatsApp.

While none of this has actually happened, conditions seem quite ripe. A disruptive idea like this would be brilliant.

And the Foolish bottomline is...
The criteria that investors like Warren Buffett use for assessing a business are very useful. A key question he asks is "Does it have a moat?" This is a crucial one for technology companies. With Facebook having a market capitalization close to some of the leading banks and a far greater P/E, its moat needs to be carefully examined. Buying disruptive businesses hardly counts, but being disruptive consistently could be it.

Renjit Ebroo has no position in any stocks mentioned. The Motley Fool recommends Facebook, Google, LinkedIn, and Twitter. The Motley Fool owns shares of Facebook, Google, and LinkedIn. 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.

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