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Facebook-WhatsApp Deal Haunted by Past Web Merger Flops

Facebook Inc. (FB) investors who pushed the company’s shares to a record after it unveiled the $19 billion deal for WhatsApp Inc. would be well served to remember -- every Internet takeover of more than $10 billion has flopped.

Last week’s proposed purchase would be the biggest Web acquisition in more than a decade and only the fifth ever to top that threshold, according to data compiled by Bloomberg. That puts it in the same category as AOL’s merger with Time Warner and Terra Network SA’s takeover of Lycos, which later resulted in multibillion-dollar writedowns.

The history of large Internet deals is littered with buyers who paid lofty valuations for targets -- Facebook is bestowing on WhatsApp a multiple typically reserved for companies developing life-saving drugs -- only to see their value erased. Facebook Chief Executive Officer Mark Zuckerberg, who said this week that WhatsApp is worth even more than the $19 billion he’s spending, is betting this time is different. His take: WhatsApp will grow beyond 450 million active messaging accounts to justify the investment from the world’s biggest social-networking service.

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“History shows that when you pay $19 billion, there’s an opportunity to have overpaid by $19 billion,” said Jay Ritter, a finance professor at the University of Florida. “A lot of things have to go right. And there’s certainly a price point at which even if things go right, it’s not going to be a good investment.”

Photographer: David Paul Morris/Bloomberg

Mark Zuckerberg, chief executive officer of Facebook Inc. Close

Mark Zuckerberg, chief executive officer of Facebook Inc.

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Photographer: David Paul Morris/Bloomberg

Mark Zuckerberg, chief executive officer of Facebook Inc.

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Many investors and analysts are positive on the deal, with Facebook reaching an intraday record of $71.44 this week. The Menlo Park, California-based company currently trades at 55 times projected earnings for this year, compared with 23 for Google Inc. and 14 for Microsoft Corp., both of which had also expressed interest in buying WhatsApp, people with knowledge of the matter have said.

None of the 51 analysts tracked by Bloomberg have a sell rating on Facebook, even though $12 billion worth of new stock will be issued to pay for the deal.

The deal to buy WhatsApp, at 19 times projected sales, comes as the technology laden Nasdaq Composite Index surges back to near dot-com era levels. The index is up 38 percent in the past 12 months and 14 percent shy of its record of 5,048.62 on March 10, 2000.

Facebook’s latest acquisition is the biggest Internet transaction since Time Warner’s $124 billion merger with AOL at the peak of the technology bubble in 2001. Two years later, it led to a $45.5 billion writedown after promised revenue gains and cost savings from combining their media and Internet businesses failed to materialize.

Expensive Purchase

In 2000, VeriSign bought Network Solutions for $15.3 billion, seeking to expand in website registrations, and three years later sold it for about $100 million as growth faltered. Terra Networks took over Lycos for $13.8 billion and divested the Web portal for $95 million. Telecom Italia’s media unit bought Tin.it for about 30 billion euros in 2000, later revaluing it at $1.2 billion when the parent bought it back.

The comparison is a “naive argument,” Neeraj Arora, who runs business development at WhatsApp, said on Twitter today. “Price alone cannot be an indicator of success in M&A. Every deal is different and unique,” he tweeted.

Zuckerberg said that making money off the messaging app isn’t going to be a priority and that advertising, Facebook’s main business, would not cross over onto the application. Daniel Ernst, an analyst at Hudson Square Research in New York, estimates Mountain View, California-based WhatsApp’s 2013 revenue at about $20 million.

Another Billion

“This incredibly expensive purchase can only possibly be justified for strategic reasons as they are removing yet another possible competitor,” said Lex Van Dam, a fund manager at Hampstead Capital LLP in London.

Zuckerberg, who negotiated a deal with WhatsApp CEO Jan Koum in about five days, said the app is on track to grow to 1 billion users -- a size he thinks makes the network inherently valuable. Tucker Bounds, a spokesman for Facebook, referred to Zuckerberg’s statement in response to a request for comment.

“The price is unheard of, obviously, but it’s a very smart move by Zuckerberg,” said Eric Jackson, president of Ironfire Capital. “I think he’s intent on buying any young new service that has the potential to topple Facebook from its top spot. The market is giving him a big stock price, so he’s making these big stock deals.”

Growth Trajectory

Scott Kessler, an analyst at S&P Capital IQ, compared the WhatsApp acquisition to Google’s purchase of YouTube or EBay Inc.’s merger with PayPal. The valuation appears to be lofty at first and then contributes to an essential transformation of the business, he said. The verdict is also still out on Microsoft’s $8.5 billion acquisition of Internet voice-calling service Skype in 2011. The key question is whether Facebook is buying WhatsApp at its peak, or an early growth stage, he said.

The risks to the deal include the possibility that the business doesn’t grow as much as Zuckerberg expects, or that another technology emerges to threaten the combined company.

“It’s hard to know to what extent WhatsApp’s growth trajectory is sustainable,” Kessler said. “It’s just difficult to really support a commitment of that amount of capital, at that valuation, without having a greater level of confidence in the long-term business prospects.”

WhatsApp will be introducing voice functionality later this year, making it a more attractive product, CEO Koum said on Feb. 24. Facebook is also rolling out mobile products separate from its main application, such as Facebook Messenger and Paper, a news-reading application.

Monopoly Money

WhatsApp Messenger is ranked No. 8 among free applications in Apple Inc.’s App Store, while Facebook’s own Messenger service was No. 12. In the Google Play store, where Android smartphone users download software, Facebook’s Messenger program was No. 3 while WhatsApp trailed at No. 11.

Facebook’s deal to buy WhatsApp has also fueled interest in other messaging providers, including Tango and Line, which have fielded takeover advances. BlackBerry Ltd. (BBRY) CEO John Chen said on Feb. 25 he’d eventually consider spinning off or selling the smartphone maker’s BlackBerry Messenger service. Other messaging applications include Kik, KakaoTalk and SnapChat, the photo-sharing tool whose parent rebuffed a $3 billion offer from Facebook last year.

“There’s no way as a financial analyst I can sit there and justify the number,” Ernst said of the WhatsApp deal. “They may never monetize this. It’s taking one inflated asset and buying another inflated asset. It’s like Monopoly money.”

To contact the reporter on this story: Sarah Frier in San Francisco at sfrier1@bloomberg.net

To contact the editor responsible for this story: Pui-Wing Tam at ptam13@bloomberg.net

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