Will Facebook Be Able to Make WhatsApp Pay?: Leonid Bershidsky

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With the acquisition of WhatsApp, Facebook is buying into a messaging revolution. According to the tech intelligence firm Analysys Mason, the total volume of messages sent from mobile devices via so-called over-the-top messaging services exceeded SMS -- more traditional mobile text messaging -- volume for the first time in 2013. Services such as WhatsApp handled 10.3 trillion messages, compared with 6.5 trillion for mobile carriers.

WhatsApp, with its 450 million monthly active users, reported a record 10 billion inbound messages on one June day in

2013. With WhatsApp adding about a million new users a day, 10 billion messages could also end up being its daily average for the year. That would give the service a 35 percent share of global traffic, making it the biggest competitor to SMS in the world.

As Facebook's Chief Financial Officer David Ebersman pointed out during a call with analysts following the acquisition announcement, text messaging is a $100 billion business for mobile carriers. "So this is a really valuable service that people are willing to pay for," he said.

The point of WhatsApp, however, is that people don't want to pay for instant messaging. WhatsApp costs $1 to download, and it charges $0.99 for a year of use, starting from the second year. That may be enough to pay salaries at the very frugal company, which doesn't advertise or even have a sign on its headquarters in Mountain View, California, but it's nowhere near enough to justify the $19 billion price tag.

WhatsApp co-founder Jan Koum is an avowed enemy of advertising. He allowed Sequoia Capital to invest in his startup only on the condition that the venture capitalists not push the advertising model on him. On the call, Koum said that he was counting on his subscription model to yield more money as the user base continues to grow: "As we look forward to the next five or 10 years, 5 billion people will have a smartphone and we have a potential to have 5 billion users potentially giving us money."

That prediction is probably overly optimistic, mainly because WhatsApp is far from the only widely used OTT messenger. Viber, run from Cyprus by a group of Israeli entrepreneurs, claims 105 million monthly active users. The Japanese messenger Line, popular throughout Asia, probably has about the same number of users. Chinese Web giant Tencent's WeChat app had 272 million at the end of the third quarter of 2013. If Facebook is stuck with Koum's subscription-only model, it will need to somehow defeat all these competitors.

Mobile messengers are viral products that spread like wildfire in a country or region because they have features that people in that area appreciate. WeChat lets its Chinese users book taxis and top up phone credit. Line runs flash sales in Thailand. KakaoTalk, installed on nine of 10 smartphones in South Korea, gets most of its revenue from games it allows users to play. Pavel Durov, founder of the Russian social network Vkontakte, which is more popular in its home country than Facebook, last year started a messenger called Telegram, which Durov says is more secure than any other platform. It is rapidly gaining new users in the Middle East.

WhatsApp itself initially took off among Russian emigres in the U.S. and their friends back home, but then spread.

I don't use any of these services because I own an iPhone, which comes with a simple OTT messenger of its own, called iMessage. It works only on Apple devices, but then most of my friends use them, and almost all the others are reachable on Facebook's own messenger.

Of all the popular OTT messengers, WhatsApp is the only one that costs money to download or charges for a subscription. The Asian messengers in particular are more versatile. KakaoTalk gets 26.2 percent of its revenue from advertising and 6.3 percent from selling emoticons. The latter is a major revenue source for Line, too. Only the euphoria of a multibillion-dollar payout could have led Koum to predict his app would win 5 billion active users in such a market.

Facebook's biggest acquisition, of course, is consistent with the recent trend for big tech deals: Investors pay for users, not revenue. Zuckerberg, for his part, liked the high engagement of WhatsApp users. If the company's numbers are correct, each user sends an average of 30 messages a day. So what if it doesn't matter in a subscription model?

Less than a week ago, Japanese Internet retailer Rakuten said it would buy Viber for $900 million. That's $8.60 per monthly active user. The stock market punished the Japanese company for the deal. Facebook is paying $42 per monthly active user for WhatsApp. True, $15 billion of the price is in Facebook shares, which may be an overvalued currency -- the company is trading at 113 times earnings. Still, even if the Facebook shares are worth nothing, the $4 billion in cash portion values a WhatsApp user, with his $0.99 annual subscription, at $8.90.

Facebook's strategy of buying the most popular mobile services in various categories -- Instagram in photo sharing, WhatsApp in messaging -- is about territorial grabs rather than any kind of financial planning. The inflated stock price allows the social network to make bold plays. Facebook apparently made a successful bet with Instagram, which is expected to earn as much as $400 million in revenue this year. WhatsApp is a more difficult proposition. Making it more dominant globally, and making it pay within the limited model proposed by Koum, and approved by Zuckerberg, will be a challenge. It is hard to believe that the word "advertising" will not come up in internal discussions in the next couple of years.

(Leonid Bershidsky writes on Russia, Europe and technology for Bloomberg View. Follow him onTwitter at @Bershidsky.)

To contact the writer of this article: Leonid Bershidsky at lbershidsky@bloomberg.net.

To contact the editor responsible for this article: Mark Whitehouse at mwhitehouse1@bloomberg.net.