WhatsApp, $19 Billion, and the Unreal Economy of Silicon Valley

Xconomy National — 

Facebook announced Wednesday that it will acquire mobile messaging provider WhatsApp, a five-year-old startup in Santa Clara, CA, for $4 billion in cash, $12 billion in stock, and another $3 billion in restricted stock units. So, $19 billion when all’s said and done.

The deal is eyebrow-raising on any number of levels. What made WhatsApp attractive to Facebook, clearly, was one very big number, its 450 million users, and one very small number, its 35 employees. It would be hard to think of any other company that has achieved a higher valuation relative to its size ($543 million per employee). But perhaps—just perhaps—such a price tag is justified by WhatsApp’s unheard-of ratio of users to employees, which is about 12.9 million to one.

On the subject of big numbers, how much is $19 billion, really? A few comparisons may be helpful. $19 billion is more than the gross domestic product of Honduras, Jamaica, Iceland, Nicaragua, and 80 other nations. It’s more than the annual revenue of 355 of the Fortune 500 companies. It’s equivalent to the net worth of hedge fund multibillionaire George Soros—and only 29 people in the world are worth more than Soros, according to Forbes.

It’s enough to fund NASA’s Mars Curiosity rover mission six times over. It’s roughly the amount Google has spent on its last 15 big acquisitions combined (that’s only counting the deals where the sale price was disclosed; in another 29 Google acquisitions over the same period, it wasn’t). It’s more than anyone has ever paid for a venture-backed startup. It’s very likely more than the sum total of all exits by technology companies in Boston, Xconomy’s original hometown, over the last five years (though again, deal amounts aren’t always published). It’s roughly the same amount that the bankrupt city of Detroit owes to all its creditors combined.

Which is to say, we aren’t talking about the real economy here. Only in today’s Silicon Valley could a company this insubstantial bring a price this fanciful.

There’s no point in asking, as so many have this week, whether WhatsApp is really “worth” $19 billion. An Uber ride across midtown Manhattan may be worth $200 to you if it’s New Year’s Eve and you dislike the subway. Mark Zuckerberg was willing to pay $19 billion to own WhatsApp, so that’s how much it’s worth.

A better question set of questions would be:

1. What does it mean for the rest of us when such a small company can create such a fantastic amount of value in such a short amount of time?

2. Is this kind of exit a sign that venture-backed innovation is working even better than we thought?

3. Can other startup founders, buoyed by WhatsApp’s success, hope to attain similar riches?

4. Should consumers now expect Silicon Valley to come up with even more time- and money-saving products and services?

My answers are not much, not really, definitely not, and maybe.

Let’s start by asking what kind of value WhatsApp really created. As with Instagram back in 2012, this is mainly the story of a tiny group of engineers taking advantage of open programming languages, operating systems, and mobile platforms (Erlang, FreeBSD, iOS, and Android, in WhatsApp’s case) to build a service that filled a niche and was effortlessly scalable. So scalable, in fact, that it scared Facebook into handing over 10 percent of its market value.

On its own, WhatsApp was a nice business, though not huge by Silicon Valley standards. After the free first year, users of the messaging app are asked to pay 99 cents per year. Let’s assume half of them do this. (The company hasn’t publicized its actual conversion rates, but most companies offering freemium services would kill to be able to convert even 10 percent of their free users to paying users, let alone 50 percent, so I think it’s a generous estimate.) Half of 450 million is $225 million per year. Not shabby for a 35-employee company.

But WhatsApp’s real superpower was not its revenue stream. It’s that the startup had entered a sector of supreme interest to Facebook. As Zuckerberg explained during a call with analysts on Wednesday, Facebook knows that it must become a mobile-first company to stay on top in social media. Millions of mobile subscribers around the globe want an alternative to pay-by-the-message SMS services (the all-you-can eat plans many Americans enjoy are uncommon in the rest of the world). WhatsApp was the largest and fastest-growing of these services.

And crucially, it was “the only app we’ve ever seen with higher engagement than Facebook itself,” Zuckerberg noted. (About 70 percent of WhatsApp users open the app once a day or more.) Facebook wants to make sure that all the time people spend texting isn’t time spent away from Facebook, but its own real-time messaging service, Messenger, has never really caught on.

Add up all those factors, and it made sense for Facebook to buy WhatsApp.

Here’s the thing: Facebook is just about the only company in the world with this particular set of goals and fears. And it has a lot of Monopoly money to play with. After a rocky post-IPO period in 2012, Wall Street decided sometime last summer that it loves Facebook after all. Now that it’s trading at almost $70 per share, it can put together all-stock or mostly-stock deals large enough to turn the heads of even the most idealistic startup founders.

(WhatsApp’s creators, Brian Acton and Jan Koum, complained on their company blog in late 2012 that “These days companies know literally everything about you, your friends, your interests, and they use it all to sell ads.” They even quoted that line in Fight Club that goes “advertising has us chasing cars and clothes, working jobs we hate so we can buy shit we don’t need.” They’re now part of a company that uses personal information to sell targeted ads for shit you don’t need, to the tune of $5 billion per year.)

There was one other company with the resources and the mobile ambitions to put together a multibillion-dollar exit package for WhatsApp: Google. And in fact, Fortune has reported, based on unnamed sources, that Google offered to buy WhatsApp for $10 billion. (According to the report, that offer didn’t come with a board seat for Koum, as Facebook’s larger offer did.)

My point is that WhatsApp’s “value” was only “valuable” to a tiny number of suitors, since they were the only ones in a position to act on it. So, yes, Ben Evans of venture firm Andreessen Horowitz is correct when he writes that “the widely discussed collapse in the cost of creating a startup in the last decade combines with both the much larger scale of mobile and the routes to market and virality offered by mobile platforms to mean that if you’re very good (and lucky) you can get to astonishing scale in a short time.” But then what? You better hope that … Next Page »

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6 responses to “WhatsApp, $19 Billion, and the Unreal Economy of Silicon Valley”

  1. Woo hoo I love when you get fired up about a topic Wade. This analysis is great. Wondering what your POV on the Viber acquisition by Rakuten is now. Maybe $900M was a bargain? Irrelevant?

    • Wade Roush says:

      Thanks Jules. Sure, the price fetched by WhatsApp makes Viber look like a bargain, but only inside this little snow-globe of rival social/media/advertising networks. I didn’t really follow Viber much since it’s out of Israel and Cyprus, and I don’t follow Rakuten since it’s in Japan. (Xconomy is hyperlocal to our nine bureaus, as you know.) From a cost-per-user perspective, Rakuten got a much better deal than Facebook (it paid $9 per user vs. $42 per user for WhatsApp). I have no insight into Viber’s demographics or engagement rates, though, so it’s hard to say. It’s clear that the big players feel they need mobile messaging tools to compete, so I’d expect some kind of move now from Google.

  2. David Hayes says:

    What a great article on silly people doing silly things, if Facebook really had some balls it would use it vast reserves and start something that will employ people or reskill people to have a better life or even help crawl out of poverty. All driven by advertising dollars – their all lunnies.

  3. Ironically, at Mobile World Congress, Zuckerberg asks the operators to offer free data so Facebook can reach the next billion consumers. Well, for $19 billion, Mr. Zuckerberg could offer 15 GB of data per year to 1 billion users for 5 years (assumption: wholesale price of $0.25/GB of data).

  4. adam_hartung says:

    Hi Wade, and great article. I’d like to add that the $19B isn’t really $19B. As you wrote, only $4B is in cash. The rest is FB stock. So, it’s a pile of paper. What’s that paper worth? Well, the sellers can’t sell it. None of it for at least 1 year, and then limited amounts for the next 3 years. What will that stock be worth in 2017? Maybe a lot more, or maybe a lot less.

    When Google bid $10B it was doing the same thing as FB – using stock. But, at Google the company value is 33 times earnings. At FB the company value is 116 times earnings. So Google currency is only worth 1/4 the value of FB currency. Therefore Google couldn’t give as much “google paper” to the WhatsApp founders as FB could give “FB paper.” According to arithmetic the FB bid is larger – but that arithmetic can change remarkably in a few months, all depending on “investor expectations.”

    Your arguments for the business case for FB are well founded. So, before we get too caught up in the price let’s be well aware that in Silicon Valley monopoly you can use your own currency and not be limited to just cash. Price isn’t what it at first looks like.

    You can read more on this – and why it’s smart for a high value company like FB to use its “currency” to make acquisitions – at Forbes.com http://onforb.es/1bIVXRy

    • Wade Roush says:

      Hi Adam. Thanks for your comment. Really great piece over at Forbes. I agree with much of what you say, there and here. But I wear at least three hats so my perspective is somewhat different from yours.

      Part of my job is to cover Facebook and its strategies for growth. I can see the business argument for the WhatsApp acquisition. I think it’s way too early to call it brilliant — the most one can say is that it’s ballsy.

      Another part of my job is to chronicle the overall innovation ecosystem here in the Bay Area. From that perspective, I think the WhatsApp acquisition is an unalloyed disaster. It will skew the expectations of entrepreneurs and investors for years to come, likely leading to massive disappointment among both. I think there used to be an assumption that the “unicorn” companies emerging from the far, narrow end of the venture funnel would be by and large benign; that they’d occasionally provide nice exits for the other companies not destined to grow huge on their own, keeping the whole system humming along. That is no longer the case. Google and Facebook and Apple, and to a lesser extent Microsoft and Amazon and Yahoo and eBay, are now able and willing to throw around so much money that it’s distorting incentives and squashing innovation.

      Finally, I write about the consumer experience of technology (that’s what the Xperience section is all about ). I don’t think it’s clear yet whether the WhatsApp acquisition will lead to greater consumer choice and convenience and lower costs when it comes to communication options. There’s no inherent reason to think that it will. A world in which most communications happens via IP, with Internet companies like Facebook as the gatekeepers, doesn’t sound much more enticing to me than today’s world of carrier oligopolies.