Is WhatsApp a $15 billion time bomb?

Is WhatsApp a $15 billion time bomb?

The Delta Perspective

Authors: Dominic Leong and Daryl Woo

Facebook’s Q3 2014 earnings announcement was the first time WhatsApp’s financial results were disclosed. The world’s largest social network initially paid a whopping $19 billion for a mobile instant messenger (MIM) that generated only $10 million of revenue in 2013. The initial price tag in cash and stock options was further boosted to $22 billion due to a rise in Facebook’s stock price.

The key highlight of the announcement was the $15 billion goodwill recorded on Facebook’s balance sheet. Simply, that is the amount Facebook recognised as the price paid above the assessed value of WhatsApp’s existing assets.

Determining goodwill is often challenging since its value can be attributed to abstract concepts such as future growth and synergies. Alternatively, one can choose the easier option of claiming that Facebook has made an irrational overpayment. While critics have largely supported the latter, a deeper understanding of the business is required to understand the long-term potential.

The Mobile Instant Messenger (MIM) business

The spine of the MIMs’ business model, akin to social networking sites (SNSs), has three key components: the user network, activity and products (see Figure 1). Together, they drive the revenue model and the profitability of the business.

Figure 1: MIM business model

Source: Delta Partners analysis

While the network forms the bedrock of the business, it will not generate any value if the users are neither active nor consuming products. In the first half of 2014, WhatsApp’s 450 million monthly active users (MAUs) only generated $15 million in revenue. This annualises to about 6-7 cents, which is still a far cry from the 99 cents yearly subscription fee after the first year of free trial.

Nevertheless, collecting a subscription fee is just not enough. Neeraj Arora, Vice-President of Business Development for WhatsApp, recently announced that the subscription fee does not apply in India due to “several ecosystem issues such as low penetration of credit cards”. We see this concession likely to apply in other developing countries as well, resulting in revenue growth to remain muted.  

Monetisation is the key

Monetising the user base is therefore key to unlocking value, and Facebook has been a role model in this aspect. Since its Initial Public Offering in May 2012, Facebook’s quarterly revenue has displayed a high exponential correlation to its market value (see Figure 2). Recent quarters after the WhatsApp acquisition have displayed even less deviation from the trend line, further supporting our hypothesis.

Figure 2: Facebook’s Market Cap per MAU vs. monthly revenue per MAU1

Note: Based on Facebook’s Q2 2012 to Q3 2014 quarterly results. Source: S&P Capital IQ, broker estimates, news reports

The exponential relationship can be explained by the network becoming more valuable as more people join, also known as the network effect. On one hand, the network becomes more attractive for prospective users to socialise in, and it also increases the loyalty of existing users. On the other, the rise in user activity will also create more monetisation opportunities.

Based on Facebook’s historical performance, WhatsApp’s negligible revenue should have resulted in a price closer to c. $17 per user or $8 billion. This, however, represents a steep discount of more than 60% from its current $22 billion price tag, raising serious concerns on whether the MIM was severely overpriced.

The WhatsApp phenomenon

Recent broker reports, however, have assigned much higher valuations to MIMs (see Figure 3). Current peer valuations indicate that WhatsApp could be worth c. $68 per user or $31 billion, more than a 60% premium to the purchase price. We attribute this to the market exuberance on the increasing prevalence of mobile platforms as the main source for social networking.

Figure 3: Brokers’ valuation of global SNS and MIM players1

Note: Based on 10th Oct 2014 close and Q2 2014 sales. * Assumes KRW9.7t domestic portal value (11.5x 2015 EV/EBITDA) ** Assumes KRW1.7t Daum value (19.5x 2015 P/E) in current Daum-Kakao market cap *** Based on MAU and sales price when acquired by Facebook. Source: Bloomberg, Samsung Securities estimate

Since WhatsApp’s perceived value is likely to continue changing over time, focus should be placed on the plans to unlock value instead. These plans have already been set in motion with the upcoming launch of voice calls and the sale of SIMs with free WhatsApp use in Germany.

WhatsApp may also consider taking the lead from its Asian MIMs Line, KakaoTalk and WeChat and introduce new lifestyle services (e.g. payment, taxi-booking, indoor map services). These features further complement its centralised messaging platform and diversify its revenue sources. This is somewhat ironic considering their previous misnomer as imitators of WhatsApp.

Facebook’s next move

However, it has been established that monetisation would not be a near-term priority. Facebook’s CEO Mark Zuckerberg established during the Q3 2014 earnings call that Facebook’s multiple products (e.g. WhatsApp, Messenger, Search, Video, NewsFeed, Oculus, and Instagram) will need to each connect 1 billion users before being aggressively monetised.

This seems aligned with the recent service spin-off from the main app into separate, standalone mobile apps. In the launch of its independent Groups App, Facebook recognised that a separate application will help to improve overall user experience and consequently user growth.

Apart from monetisation potential, WhatsApp also holds defensive value to Facebook. WhatsApp’s phenomenal user growth is generating massive amount of messaging traffic and sharing activities. At the same time, the popular social platform has witnessed decreasing QoQ and YoY growth of 16% and 2% respectively (see Figure 4), which is not surprising given its gargantuan size. This decline could have been significantly worse if WhatsApp had fallen into the hands of a competitor such as Google.

Figure 4: Facebook mobile MAUs

Note: Number of mobile MAUs do not include Instagram users unless they would otherwise qualify as such users based on their other activities in Facebook. Source: Facebook

For now, Facebook can afford to be patient with its family of products because its core advertising business continues to outperform. The impairment tests on the $15 billion goodwill should, however, start to place more pressure on both Facebook and WhatsApp to focus on monetisation sooner rather than later.


Authors’ Bios:

Dominic Leong is a Senior Associate with our Corporate Finance division and has worked on a number of M&A transactions in both the digital media and consumer internet sectors. Prior to joining the firm, he interned as an analyst at Goldman Sachs in London. Dominic graduated from the University of Cape Town with a degree in Quantitative Finance.

Daryl Woo is an Analyst with our Management Consulting practice and he was seconded to work with our Corporate Finance team assisting on due diligence, market assessment and M&A transactions. Prior to joining the firm, he interned as an investment banking analyst in Macquarie Capital, HSBC Global Banking Advisory and DBS Capital Markets. Daryl graduated from the Singapore Management University with a double degree in Accountancy and Business Management.