Facebook Does Something Cool, Probably
Oh lordy I guess I have to write about WhatsApp? There's a counter on my desk that says "____ Days Without Writing a Post on an Internet Company I Know Nothing About," and it was all the way up to 2 this morning. So much for that.
The most important thing about WhatsApp, from my perspective, is that I had never heard of it until yesterday. (You may not share my perspective.) Now that I've heard of it I have zero comprehension of how it can be worth $19 billion. You can send text messages over your phone's data plan instead of paying for the text plan? And it's free and there are no ads? Okay super.1
If you want to read words that might soothe you about how much sense this deal makes, here are some words. I cannot promise that they will soothe you; I expect that the likelihood of that declines with your age. I am too old to be soothed.
So mostly I want this deal to get off my lawn. But you should ignore that. One thing that is absolutely certain is that Mark Zuckerberg knows more about how to run Facebook than I do, and that his incentives are mostly good: He basically owns the company and wants it to succeed in the long run, and success in the long run ... oh sure let's say it involves low-cost text messaging, because that is the world we live in, a world that Facebook more or less created. Sure.
Here I guess let's just talk about the deal. Here are the press release and the 8-K. Facebook is paying WhatsApp's owners (Sequoia and its employees) $16 billion, $4 billion in cash and $12 billion in stock. It's also handing out $3 billion in restricted stock units to the employees.2 There's a breakup fee of $2 billion -- $1 billion in cash and $1 billion in stock -- in the event that regulators don't approve the deal, which is a hard outcome to imagine but I guess everyone got dressed up to do a merger and in a merger you have regulatory termination events and breakup fees and so that's what they did.
Zuckerberg, 29, then proposed that their companies join together and that Koum join Facebook’s board. Koum took a few days to think it over. Five days later, on Feb. 14, Zuckerberg was having dinner with his wife at home when Koum showed up, strawberries in hand. They then negotiated a price.
You'll notice Zuck was having dinner with his wife, not his investment bankers. I have trouble believing that banks got paid more than $80 million for that. If they did, I'd be prepared to call it a windfall.
Still I guess they did something? The deal has a bit of structure, in that it's for a mix of cash and stock. That's in part because Facebook doesn't have $19 billion in cash; it doesn't even have $19 billion in assets.3 Weirdly, the price is "subject to certain adjustments such that the cash paid will comprise at least 25% of the aggregate transaction consideration," and it's fun to imagine what that could mean.4
Here is a sensible John Cassidy column pointing out that Facebook stock is pretty much funny money for mergers, and is burning a bit of a hole in Zuckerberg's metaphorical pocket: "After all, with such a highly priced stock, Facebook faces enormous pressure to justify its valuation. In the tech industry, that means exhibiting very rapid growth rates and being perceived as the company of the future." The corollary of this is that, if you're selling Facebook a rapidly growing company built on the principles of not selling ads or collecting user information, you probably have your own doubts about Facebook's valuation. If your vision of the future is ad-free and un-snoopy, you might discount Facebook's place in that future. And then sell to Facebook anyway but for, like, really quite a lot of stock. (And a surprisingly high amount of cash.)
Back when Facebook bought Instagram for what in hindsight was a tiny amount of Facebook stock -- 1 percent of the company, rather than the almost 10 percent going to WhatsApp -- I made light of the fact that Zuckerberg apparently convinced Instagram's founder that $1 billion of Facebook stock was actually worth $2 billion. (Click the link, but it won't make any more sense.)
That was shortly before Facebook went public, and stuff like that could I guess be persuasive. Facebook was the unknown future, and that unknown future might be great. Other dreamers, such as the Instagram guys, could be persuaded to buy into Facebook's dream. But now Facebook is a giant public company, and a known quantity, and not so much the stuff that dreams are made on. And if you want the dreamers of the future to sell out their dreams for Facebook stock, I guess you have to give them a lot of it.
1 I assumed that "free and no ads" means zero revenues, and used that assumption to make a bad joke in the form of a bad scatterplot on Twitter.a But I was apparently wrong; WhatsApp seems to have positive revenues. Here is Henry Blodget:
WhatsApp ostensibly charges its users $1 per year after the first year. ("Ostensibly" because I've never heard of anyone actually paying this $1). Assuming most current users end up paying the $1/year, that's a potential revenue stream of several hundred million dollars a year from WhatsApp's current revenue model alone.
I too have never heard of anyone actually paying the $1 though my sample size is unbelievably limited (N = 1, ish). The problems go beyond the revenue model; Matt Yglesias is skeptical that using cell phone data plans to undercut SMS plans is a viable business model. That skepticism seems logical to me but what do I know what do I know what do I know what do I know.
Anyway, Blodget is right, there is roughly a 50 percent chance that this deal will work out great, and roughly a 50 percent chance that it will be a dud. Those are a priori probabilities; I would say that sentence about literally any deal, and I'd probably be right about 50 percent of the time. Efficient markets!
a Incidentally someone should do that scatterplot for real, I am too lazy and a lot of the key data (WhatsApp revenues, King Digital IPO valuation) is still not public or unknown. It would not be a huge surprise, though, to find that the regression line really does slope down, depending what you count (Facebook had an $80+ billion valuation and $4+ billion of revenues at the time of its IPO). Then one would be tempted to snark about how revenue is negatively correlated with valuation.
That temptation is worth resisting: A stock's price is the present value of its future cash flows, and you can't be a priori certain that the future cash flows of social media companies are positively correlated with its current cash flows. King Digital is super-profitable but that profit seems to be declining.
One model you could have of social media is that, in the new Internet economy, every company will be massively profitable for 15 minutes, after which everyone will quit the now expensive ad-choked profitable service and move on to the next aesthetically pleasing, free, rapidly growing service. On this model, profitable companies are the worst IPO investments, because their cash flows are, by construction, behind them.
This model is probably wrong, but it is also probably not that wrong.
3 Acquiring WhatsApp will, from a GAAP perspective, more than double Facebook's size, which is a good reason not to take GAAP accounting for Internet companies all that seriously.
4 I guess we won't know until the 10-Q is filed in the spring. But, for instance: If Facebook's stock price goes up between now and closing, does that mean that WhatsApp gets fewer shares, or more cash? If the stock goes down: more shares or less cash? Seems weird.
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