Facebook’s Acquisition of WhatsApp: The Rise of Intangibles
(A):
Susan Shaw had a number of diverse interests. In addition to a
rising legal career, she loved whitewater rafting, gourmet cooking
with friends, Broadway musicals, volunteering at the local homeless
shelter, and investing in the stock market. It was the investing
pursuit that occupied her attention this cold and rainy Saturday
morning. On her desk, she had several pages of Facebook Inc.’s
2015, 2014, and 2013 financial statements that she had had the
foresight to print out earlier in the week at the office. She was
intrigued with the idea of investing in a company that sure seemed
like an investment winner.
As she perused the financial statements, her normal starting
point for learning more about the performance of a company, the
first thing she noticed was that in the 2014 financial statements
there were some huge differences from the 2013 statement for a
number of line items, including Total Assets, Goodwill, Additional
Paid in Capital, Revenue, Net Income, and Net Cash Used in
Investing Activities (see Exhibit 1). The reported dollar amounts
for many of these items, sprinkled across the 2014 balance sheet,
income statement, and statement of cash flows, had more than
doubled. “I wonder what’s up,” she mused. “I guess I’ll need to
delve into the details to find out. It sure seems unusual that a
company could double in size in just one year—there must have been
a merger of some sort.” Indeed, a simple Google search of “Facebook
and 2014 mergers” turned up a number of hits. Eight of the first
ten search listings referred to the company, WhatsApp Inc. Her
interest was piqued, so she poured another cup of coffee and began
her methodical review.
Facebook, Inc.:
Historically, February 4 was noteworthy for a variety of
reasons. In 1826, the James Fenimore Cooper classic, The Last of
the Mohicans, was published and remains popular to this day. Almost
100 years later, in 1922, Ford Motor Company purchased Lincoln
Motor Company for $8 million in one of the most high-profile
corporate acquisitions up to that time. In 1938, Disney released
the pathbreaking and enduring animated movie, Snow White and the
Seven Dwarfs. The first electric portable typewriter was offered
for sale in Syracuse, New York, on February 4, 1957. Also on that
day, in 1998, Bill Gates, of Microsoft fame, was unceremoniously
hit in the face with a cream pie, by a local hooligan, upon his
arrival for a business meeting in Brussels. And on February 4,
2004, Mark Zuckerberg, then a 19-year-old Harvard college student,
quietly launched Facebook from his dormitory room.
Shortly after its launch, Zuckerberg was asked what Facebook
was. He replied:
Facebook is] an online directory that connects people through
universities and colleges through their social networks there. You
sign on, you make a profile about yourself by answering some
questions...[provide] contact information [and] anything you want
to tell [such as] what books you like, movies, and most
importantly, who your friends are. Then you can browse around, see
who people’s friends are, and just check out people’s online
identities and see how people portray themselves and just find some
interesting information about people. When we first launched, we
were hoping for 400 or 500 people [and] who knows where we’re going
next—maybe we will make something cool!
From Facebook’s 2014 Form 10-K available online through the
Securities and Exchange Commission (SEC) website, Shaw read:
Our mission is to give people the power to share and make the
world more open and connected...Our top priority is to build useful
and engaging products that enable people to connect and share
through mobile devices and personal computers. We also help people
discover and learn about what is going on in the world around them,
enable people to share their opinions, ideas, photos and videos,
and other activities with audiences ranging from their closest
friends to the public at large, and stay connected everywhere by
accessing our products...Our business is characterized by
innovation, rapid change, and disruptive technologies. We face
significant competition in every aspect of our business, including
from companies that provide tools to facilitate communications and
the sharing of information, companies that enable marketers to
display advertising, and companies that provide development
platforms for application developers. We compete to attract,
engage, and retain people, to attract and retain marketers, and to
attract and retain developers to build compelling mobile and web
applications that integrate with Facebook, and to attract and
retain highly talented individuals, especially software engineers,
designers, and product managers.
Shaw recalled that it had not been so long ago that there had
been quite a buzz about Facebook’s initial public offering (IPO).
Indeed, with much anticipation and excitement, that IPO had taken
place on May 18, 2012. By the end of that day, $16 billion had been
raised, indicative of a total market capitalization for the company
then of just under $91 billion. The following few years were
witness to that corporate valuation rising and falling, at times
quite dramatically. In spite of those fluctuations, however, the
general trajectory for Facebook’s valuation was positive, as were
many other aspects of Facebook’s place on the business
landscape.
Fast forward. Shaw wondered what other current
Facebook-related information she could easily obtain. Among other
things, she found that as of May 4, 2016, Facebook’s market
capitalization was just over $337 billion. In concert with that
valuation, and according to Forbes magazine, Zuckerberg was the
sixth wealthiest person in the world, with a net worth of just over
$51 billion—and by far, he was the youngest person on the Forbes
list of the 100 wealthiest people in the world. Moreover, the
Facebook global brand had risen from 69 in Interbrand’s 2012
ranking to 23 in its October 4, 2015, ranking (its brand value was
estimated at slightly over $22 billion). And the initially
hoped-for 500 users had morphed into more than 1 billion daily
active users during March 2016, supported by more than 13,000
Facebook employees. Without a doubt, not bad for “something cool”
to have emerged in just 12 short years.
WhatsApp, Inc.:
As a natural extension of her inquiry into Facebook, Shaw
began learning about WhatsApp. Five years after the birth of
Facebook, Jan Koum and Brian Acton had founded WhatsApp. They were
near fanatical about developing an instant messaging system for
smartphones focused on speed and reliability, eschewing the typical
advertising links and add-ons. In fact, at one time “a hand-written
note on [Koum’s] desk read: ‘No Ads! No Games! No Gimmicks!’” After
tapping into the SEC’s 10-K website again, Shaw read:
The Company provides a cross-platform communication
application, which allows users globally to exchange unlimited text
and multimedia (audio, video, and photo) messages without having to
pay for short messaging service (SMS) fees. Users can communicate
through one-to-one messages, create groups, or broadcast lists.
Currently, WhatsApp supports iPhone, BlackBerry (and BB10),
Android, Windows, Nokia S40, and Symbian platforms. Users can send
messages via WhatsApp application using existing mobile data
connections or Wi-Fi. The Company is headquartered in Mountain
View, California. The Company provides messaging services through
the WhatsApp Messenger application. The users pay a subscription
fee for the messaging service that the Company offers in certain
countries. The Company derives revenue from two sources: (1) term
subscription revenue, which is comprised of subscription fees from
users utilizing the WhatsApp messaging service through their mobile
devices over a subscription period of one year, three years, or
five years; and (2) perpetual subscription revenue from users
utilizing the WhatsApp messaging service on mobile devices that
have perpetual subscription periods.
Several recent news articles that Shaw also came across
provided some updates. Until recently, the user subscription fee
was only $1 a year. Because most users were outside the United
States, in January 2016, WhatsApp announced it would drop even that
low fee “and explore ways that businesses can interact with the
mobile messaging service’s users.” According to Koum one of the
co-founders, the subscription fee “really doesn’t work that well in
a lot of countries, and we just don’t want people to think that
their communications with the world will be cut off. Many users
don’t have a debit or credit card to let them pay for the service.”
After being acquired by Facebook, WhatsApp remained adamant that it
would not move to a model relying on “third-party ads to compensate
for the loss of annual revenue fees.” It remained an open question
of how best to monetize the “one billion monthly active users who
send 42 billion messages and share 1.6 billion photos a day.” And
undergirding this huge amount of activity was only a handful of
engineers—about 50.
The Acquisition:
On February 19, 2014, almost 10 years to the day since
Facebook was founded, the company announced it had reached a deal
to acquire 100% of WhatsApp shares for $19 billion. Shaw was struck
by the unabashed, immediate exclamations coming from the business
press describing the purchase price as “insanely high,” “an
eye-watering amount,” “a stunner,” “staggering,” “jaw-dropping,”
and “a deal of historic proportions.” At that point in time,
WhatsApp was unprofitable (Exhibit 2), had a total of 55 employees,
450 million monthly users, 1 million new users signing on per day,
no ads, no platform for games, and a $1 annual fee after a free
first year of use. Despite these mixed indicators (i.e.,
unprofitable but lean in size, miniuscule revenue stream but
impressive user growth), the acquisition price was indicative of a
market capitalization for WhatsApp that exceeded that of such
well-known and well-established companies as American Airlines,
Ralph Lauren, Campbell Soup, and Coach. As another point of
reference, Facebook had purchased Instagram two years earlier for
$1 billion; Yahoo! had purchased Tumblr for $1.1 billion in 2013;
and Microsoft had paid only $8.5 billion for Skype in 2011. The
Facebook deal to acquire WhatsApp was epic by all accounts, but was
it a stroke of genius by Zuckerberg or was it a high-priced “roll
of the dice” for possibilities, ideas, and access to a handful of
talented individuals?
READ the above case before answering the question below.
Question 1:
What strategic moves were perhaps fueling Facebook's interest
in acquiring Whatsapp?