An App for Your Country?

The world’s gone “tech crazy” once again. recently ran a great article showing the buying spree in the new “Dotcoms.”

I’ve nicked the graphic they used in the article, which so eloquently shows the timeline in the current round of acquisitions:

whatsapp bubble
In the spirit of educating myself about the apparent bubble in the social media and app spaces, I figured I’d take a closer look at Whatsapp. My first impressions seemed to indicate that Facebook’s Zuckerberg must have been dropped on his head as a child, and the rest of the Facebook management team is just fast asleep or partaking in some very good drugs.

Let’s first revisit the sale. $4B in cash, $12B in Facebook shares and $3B more in restricted shares. I’ve been involved in dozens of private equity transactions, reviewed hundreds, perhaps thousands more. You stop counting at some point. Some things just jump out at you after a while, and looking at this closer some things are clearly evident.

First up, $4B cash and effectively $15B in stock…

  1. Facebook must believe their stock is overvalued. You use stock to purchase when your stock is pricey. You use cash to purchase when your stock is cheap. What we have here is the flipside of buying back stock.
  2. The $3B in restricted stock. This is smart because once again the valuation is pretty rich at a P/E of 103.
  3. The low cash payment. This too makes sense when you realise that earnings are not stellar, certainly compared to valuation. It’s like having a $2M pool of assets which throw off such a tiny yield that you’re actually struggling to make ends meet, but your balance sheet says you’re wealthy. I know quite a few guys like this in the real estate space.

Digging a little further than just the headline, let’s try figure out whether Whatsapp is actually a good business.

They have 450 million users and they add a whopping 1 million new users every day. Impressive! At this rate it’s not hard to imagine them reaching a billion.

OK, so user growth is rampant, next let’s see what sort of OPEX is required to support, or “onboard” these users.  They have just 32 engineers for the 450 million current users. That’s over 14 million users per engineer. Yikes. Once again, very impressive.

The business model is to charge $1 annually. From a user’s perspective this is a bargain, as it will save them a ton of money on texting.  I don’t know what the average user currently spends annually with his phone provider’s text plan, but I’ll take a guess it’s closer to $100 than $1. In fact, Mark was recently in a mobile providers store in Auckland and the sales guy was telling a new customer to forget texting, “just use Whatsapp.”

OK, I get the value proposition. Their marketing seems very simple. I like simple. There are no ads, no popups, no games. Very clean. What you see is what you get. Great, love it. As a user I don’t get annoying advertising interrupting my experience.

So what are the user acquisition costs? Apparently their user growth has been all by referral. Zero, zilch zippo money spent on user acquisition. This epitomizes viral. On this front they’ve clearly nailed it.

But what hits the bottom line is what matters right? Net profit margin is currently 50%. This is very, very competitive. Google and Facebook for example run about 20% net. We can see that this is because they are sticking to one solid business line and their cost of maintaining their clients is fractional.

The Valuation Metrics

Lets try and value this business on a Price to Earnings basis.

  • Current P/E  = $19B/225m (450m x 0.5) = 84x
  • If they hit 1 billion users and suffer no substantial changes to their profit margins, then a forward P/E would be $19B/500m = 38x

That doesn’t seem too bad a multiple compared to Facebooks PE of 103x, but then given that Facebook is far from cheap I’m not too excited.

How about their price per user acquisition/client.

  • At $19B for 450 million users we get to $42 per user
  • On a forward basis assuming they get to 1 billion users we get $19B/1B which of course is $19 per user.

One way to look at this is to say, “OK, how long for me to recoup my capital from each user?” Well, it’s either 42 or 19 years. What pray tell does the tech industry look like in 42 or even 19 years? I don’t pretend to know, but the odds are Whatsapp won’t even be around. Sorry, it makes no sense to me.

What about the Price to Sales Ratio?

  • This of course mimics the above calculation simply because revenue per client is $1.
  • Price to sales of 42x or even 19x is just loopy in my opinion. Where is the upside?

In this insane world of QE and rate suppression revenues and profits no longer seem to matter. I see it in the real estate markets all around the world and in many public equity markets.

Asset valuations should always be a reflection of revenues in the same way that a person’s income should be the driver behind the price of their home. This is no longer the case. Thank you “Uncle Ben” (and now Janet Yellen), thank you Mario Draghi, thank you Haruhiko Koruda and all those who follow in your paths.

The photo above was taken two weeks ago at the Colombo Stock Exchange in Sri Lanka, where the total market cap of all listed companies is a mere $20 billion USD. Now I ask you, which would you rather own? One of the fastest growing countries in the world with one of the best-performing stock markets on the planet over the last decade? Or, an overvalued (by its own actions) social media company investing in an “App” that is likely to become obsolete overnight?

Short Facebook, long Sri Lanka? I could think of worse trades.

– Chris

“Can we go back to using Facebook for what it was originally for – looking up exes to see how fat they got?”  – Bill Maher


This Post Has 5 Comments

  1. Thomas

    Hi Chris,
    these calculations don’t involve the value FB must attribute towards metrics that are hard to quantify for outsiders like user behaviour, possible future implementations of the software, data (after all their business model is build heavily on data, like Google’s) and much more. e.g. i assume they could just as well charge $2.49 per year without a big change in the customer base.
    That’s what makes it hard to apply these simple valuation metrics, which I assume date back to a time, tech wasn’t really around yet, from more traditional industries to tech.
    As Google bought Youtube in 2006 it was said to be ‘expensive’ and just a few were able to imagine where they would go with it – look where it is now.
    I am not saying it was a good acquisition rather extremely difficult to judge from the outside.

    1. Chris MacIntosh

      Hey Thomas

      I agree wholeheartedly. If you run a business and can see a means to create a ton of value in another business then this makes sense. At the same time typically (and I’ve been in this situation more than once) you don’t want to be buying a business for anywhere near its future value. You want to be buying it for current value and then bringing that future value to fruition. As such it does make sense to value the business as it exists today. Sure they may take this business to billions in revenue annually with a few tweaks but ideally you want to be buying it for present not future value and then adding that value so its accretive to shareholders. The other aspect to consider of course is what the entire industry looks like in 10 years time. There is a lot of hot money flowing into this space and every time in history this has happened stupid decisions are made and people lose money. I don’t know if this will happen with Whatsapp but I’m convinced it will happen in the social media/app sector of the market.

  2. Daniel

    I can totally see Whatsapp crash because other companies would do the same.

    The truth is their business model only exists in the first place because cell phone operators were priviledged by government barriers to entry and competition. Mainly by regulating the bandwidth aquisition and use, but also by telecommunications regulations that demand a lot of equipment and operations to comply to myriad of regulations. A hard proof of that is the ridiculously large profit margins of text messaging services cellphone operators earn.

    Whatsapp found a loophole to telecomunications barriers to entry, a substitute service. But I doubt cellphone carriers will stay put while they loose their monopoly prices, there is a great risk that they will push some regulation tweaking that could effectively make Whatsapp unviable.

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