Re: Facebook Whatsapp
Roseanne Devon
While I agree with the obviously true conclusion, I'm not sure how you drew the conclusion "user engagement matters" given that none of the metrics used measure user engagement.
Small point, but it bothered me while reading.
Thanks for these anyhow, AD.
Fantastic post.
But on the value side of the equation, I would think the required equity return should be a LOT higher than the 8% broad market return. Bumping 8% up to 10% seems like small premium for a stream of cash flows with so much risk. A 20% required return seems more like a fair ballpark to me.
If only some other companies could convince the Street to start valuing them based on 'users'. How many people in the world use Google? Slap a $130/user valuation on. I am sure even YHOO has some engaged users.
Why stop there? Wal-Mart has a lot of 'engaged users' too. They're just called customers because they actually make money off of them.
One other point re: the value equation. They have basically no cost at this point...but from a customer service / back office standpoint if a minimum wage employee had to spend 10 minutes a year / per customer once they charge money for their services -- that would eat into 40% of a $5/yr revenue stream.
I appreciate your contrast between traders and investors, but is it appropriate to view Facebook in that context? It's not like they're going to flip WhatsApp three months (or three minutes) from the time of purchase. It is foolish for corporations to think about acquisitions in any terms other than the free cash flow they expect to generate from the acquisition.
another possibility is that FB might also try to adopt WS' proven paid model to FB's other value-added services (no ads, career connection ... etc). if so FB could generate significant revenue to justify its acquisition of WS.
Pretty clear he "goal seeked" that 160mill number to make a point.
But the larger point is- are there any new users? Is there anyone who uses Whatsapp but doesn't have a facebook account? Is this a significant number? If not, all this means is Facebook is "re-buying" their users. Kind of like maintenance capex if you ask me. I think FB understands they have no moat and have to keep buying their users to maintain their advertising revenue stream.
Interesting. I don't think you quite capture what is driving the traders.
What problem do the Traders solve?
Though you do indirectly state the problem they solve: How do you value a company whose earnings are far in the future? You don't center your argument on that. I think the answer links Traders and Investors - in your story and in practice.
We can tell any story we like about what WhatsApp's future earnings - almost anything is plausible from 0 to several billion in 5-10 years.
Traditional investors aren't willing to deal with the uncertainty.
Traders are willing to - up to a point. They use the best thing available as clues to what may happen. WhatsApp has some value, and it will have some future earnings. Rather than wildly telling any story, it is actually a cautioning measure to rely on the few things that are known to anchor estimates of what may unfold in the future.
In reality this is the same thing investors do. Companies are not valued because of the earnings they have had, but because of the earnings they will have. Using current fundamentals to guess what future earnings will be is exactly the same process that traders using users use. the difference is that the confidence intervals have a different shape and a very different term structure.
Since the WhatsApp users are teenagers they are also likely to already have a FB account. Therefore, the number of new FB users may be closer to zero than the required 160 million needed to justify the traders numbers... ouch!
As others have noted, there is almost definitely an overlap between FB users and WhatsApp users. Anecdotally, everyone I know who uses FB, also uses WhatsApp. They just use the two services for different reasons. So even if you are a trader, you cannot justify the price based on users, as then FB is simply paying itself for its own users, which would be ludicrous. Personally, I think FB is just paying $19 billion because it can, and there is nothing to justify it. I mean why did they choose $19 billion? Why not $22 billion? Perhaps they chose the number based on how many chocolate strawberries they ate at their supposed deal dinner, with each strawberry worth $1 billion. One thing I am fairly certain of, Zuckerberg is surely laughing at all of Wall Street for helping him print this kind of absurd money at will and justifying it.
Dan,
Interesting point about traders but I don't buy the story. It is true that a subset of investors, the old time value investor school, will not be drawn into buying shares in any growth or risky company. However, there are growth investors (Peter Lynch, for instance) who do value risky companies and invest in them.
In fact, traders go wherever there is action. Thus, if there is action in Coca Cola, they will be there as well.
Interesting post, wish you'd written this before though, as I may have taken a different path. I am now short in large size Tesla/Facebook/3D Systems as well as the Russell 2000. I cant reasonably get out of the trades now (in illiquid options), if there isn't a dramatic fall between May and year end my net worth will have dropped from relatively considerable to close to 0. Think I might be putting serious strain on my heart (at age 32) .. no joke.
I think traders' point of view and their laughing away to the bank is just about the greater fool theory. Your analysis about cash flows and risk, and break-even is correct. But you too as an investor would agree that this kind of speculation (yes it is that) is not going to last for long. All bubbles are going to burst, sooner than later. History is backing up for that. For a no income model business any price is speculative, $19 B is a joke. Unless of course there is a plan to monetize 450 M users and continue to increase user base. FB better explain the rationale rather than talking only about users. The only consolation is $15 B paid in overpriced speculative stock. Yet, what about that $4 B cash, isn't that too much for a zero-earnings business? For us it indeed will be interesting to see how all this unfolds in future, let's watch that space for the fun-ride.
I think it should be free cash flows of $1.52 B that are required to get $19 B value rather than earnings. Is it that you consider in perpetual state depreciation would equal reinvestment so that earnings = FCFF?
Sorry it should be FCFE.
I think it should be free cash flows of $1.52 B that are required to get $19 B value rather than earnings. Is it that you consider in perpetual state depreciation would equal reinvestment so that earnings = FCFE?
Aswath,
The value comes from every person who downloads and uses the app must upload their contact list, and therefore, FACEBOOK now has access to your friends listing, your likes, and dislikes through the message that you post, your friend's name with their respective cell phone number. You can literaly say that you will know the most intimate thing about this person (better than your competitors). Now, you can then use that information to increase your revenues, and we are not just talking about $1-$5/person.
Thanks for this analysis and I think this is a very useful way of thinking about this value / price discrepancy.
I have a few comments on your observations:
1. It is alright not to make a moral judgement on traders vs investors. However, Facebook is not a trader and should it be drawn into the trader's game of valuing a company that it wants to acquire in this way with little correlation with fundamentals?
2. I admit that some of the risk above is mitigated by paying in shares as FB is being valued on the same metrics. However, the value of attracting whatsapp users to facebook, i.e. "synergies" is something that is relatively risky and unknown. I would think that your back of the envelope shows that FB needs to attract 160m whatsapp users who are already not using facebook. I dont have the numbers on how many users of whatsapp dont use facebook but I would think there is some overlap already. Which means that this is by no means an easy task. Further, it is also not clear how this will be done if whatsapp continues to function as an independent service.
3. Assuming that the synergy value can be justified by $130 x expected new facebook users, hasn't facebook already paid away largely all of this value?
4. I would argue that the balance of upside / downside is very skewed here against the existing shareholders of FB even if you leave aside fundamental valuation principles and continue to use the $130 pricing metric. If FB can achieve the very difficult task of attracting 160m new users, the existing shareholders will be no better off (or maybe marginally better off depending on what the actual numbers turn out to be). However, the downside if FB is not able to achieve this is much more material.
5. This may not have been acceptable to Whatsapp shareholders, but I would have thought that a better way to structure this deal would have been to link the number of shares to be paid to the number of additional users generated. I am not sure if there is way for them to measure this. However, if this is possible then the value of these synergies is paid as and when they are realised. This method would continue to use the trader / pricing view of the world but ensure that existing shareholders are getting a fair deal.
NA
Dear Aswath Damodaran, Thanks for writing this excellent piece. However I think it is great that Facebook is bold and buying other companies to continuously grow.
On the other hand we have companies like Apple who have resorted to share buyback as increasing the value of company. I recently wrote an article on what I think of Carl Icahn's strategy for apple. -carl-icahns-strategy-of-asking-apple-to-buy-back-stock-is-wrong/