By David Nelson, CFA
It’s going to be pretty hard to come up with any metric that could justify Facebook’s (FB) acquisition of messaging start up WhatsApp at a cost of $16 Billion. The outlay consists of $4 Billion in cash, 184 million (FB) shares with a value of approximately $12 Billion. Additionally there is $3 Billion in restricted stock units that vest over 4 years, bringing the total to a staggering $19 Billion.
Perhaps 5 years from now we’ll look back and thank Mr. Zuckerberg for his incredible insight but for now it smells more like arrogance, fear and desperation. Management sees something in their user metrics that points to future loss of market share to messaging companies or a demographic trend they find concerning.
To put the price being paid in some perspective, with a potential market cap of $19 Billion, WhatsApp is now bigger than more than half the companies in the S&P 500. The list includes the likes of The Gap (GPS), Dollar General (DG) and Chipotle (CMG). At a cost of $42 per subscriber, who by the way pays nothing in their first year and $345 Million per employee (55), the deal seems a bit out of control. (Click Here for Full List)
Risk vs. Reward
Regardless of the success or failure of the acquisition, it represents an irresponsible allocation of shareholder capital. Risk vs. reward has to be the acid test for any acquisition, and at least from my vantage point this purchase does not pass.
Even if I put the obvious dilution aside, there are several red flags that need to be addressed. After the news I downloaded the app to my iPhone. Look I get it. It’s cool with a lot of bells and whistles for those who like to chat and interact with their friends. The company currently boasts 450 million subscribers worldwide and for now growing at about 1 million per day. I’m certain somewhere down the line they will enhance this platform into more features for consumers and attempt to monetize the asset. Currently the service is free for a year and then charges you $0.99 annually. Let’s be generous and call it $1.
A Value?
Depending on your vantage point one might come to the conclusion this is a bargain. At $0.99 a year per user they paid a little over 2 1/2 times sales. Not bad for a fast growing high margin company. Of course to get there, WhatsApp will have to sign up every man, woman and child on the planet.
Not surprisingly, Jim Goetz of Sequoia Capital praised the deal. Why wouldn’t he? Sequoia invested $8 million in the startup a few years ago and is looking at a staggering pay day when the deal closes.
Public vs. Private
Facebook is relatively young as a public company. When you are private you can take huge risks and reap the rewards or failures that come your way. As a public company both the CEO and board have to consider risk vs. reward, or at least they should.
The Conference Call
I’ve read the transcript from last night’s conference call several times and still can’t believe the extraordinary lack of detail. When asked about the demographic breakdown by Nomura Securities Analyst Anthony DiClemente, Facebook CFO David Ebersman gave a long winded answer. Let me shorten it for you. We Don’t Know.
Perhaps the most interesting observation was when several analysts asked management how they will monetize the asset. Not one came back with a follow-up when they were told the company doesn’t have any plans and that monetization isn’t a priority.
Last time I looked, a stock gives a shareholder the right to participate in the earnings stream and dividends of the company. It seems this deal takes the term back-end loaded to new heights. Over the next several months we are going to see very creative analysis as the street attempts to justify the valuation.
When asked how they arrived at the purchase price, it seems the only thing that mattered was how fast they are growing. No discussion of potential earnings accretion, cash flow, yada yada yada.
The Street
Most of the research notes this morning praised the deal pointing to the future pay-off. The question remains, just how far into the future are they looking. For now, it seems estimates have to come in. The commentary had just a whiff of the kind of rhetoric and rationale we saw during the dot.com era.
CNBC
When asked on camera this morning by CNBC’s Steve Liesman; “What do they need to get out of this on a per user basis or dollar flow to make spending more worthwhile then putting it in a treasury?”
BTIG analyst Richard Greenfield said; “I don’t think there is any financial metric that’s gonna say hey on this metric over the next 5 years this deal is going to make economic sense…”
Really! It seems all of this is on the come and we are being asked to look into the future as far as the eye can see. Well, at least as far as I can see. Shareholders will cast their votes this morning. I cast mine last night in the aftermarket selling our position at $66.44.
For now, I choose not to play the part of the Greater Fool.
