The Telegraph
Saturday , February 22 , 2014
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Behind the Facebook gamble
- In $19-billion WhatsApp deal, Zuckerberg puts users before profit

Mark Zuckerberg

Feb 21: Technology companies have always been paranoid about missing the next big thing, be it email, e-commerce or social media.

Yet today, with Google, Facebook and others all fighting for the same customers and wallets, the competition has never been more intense, and big companies have never had to act so quickly — and with such conviction — to avoid being left behind.

This changed landscape helps explain why Facebook on Wednesday made what appears to be one of the largest gambles in the recent history of corporate America, agreeing to buy the text messaging start-up WhatsApp for up to $19 billion.

In doing so, Facebook has wagered a full tenth of its own market value on a belief that phone calls will become increasingly obsolete, while short messages sent from mobile devices will remain ascendant.

Mark Zuckerberg, the co-founder and chief executive of Facebook, is also betting that at some point down the road, his company will be able to make huge sums of money from WhatsApp, a service that has 450 million users.

And by offering such a staggering sum, Facebook achieved a critical strategic goal: ensuring that WhatsApp remained out of the hands of its chief rival, Google.

The purchase — among the largest Internet deals ever and the biggest by far in Facebook’s 10-year history — is a milestone that signals the arrival of an intense new phase of corporate competition in Silicon Valley.

“These big companies feel like they can’t afford to lose mind share and time share to competitors,” said Aileen Lee, a partner at venture capital firm Kleiner Perkins Caufield & Byers. “And they are willing to pay a lot of money for large user bases.”

Google was among the companies that wanted to buy WhatsApp and recently offered $10 billion for the company, which has just 55 employees.

WhatsApp turned Google down, unimpressed. Instead, WhatsApp’s co-founder and chief executive, Jan Koum, paid a visit to the suburban home of his friend, Zuckerberg.

The two men had shared dinners and hikes in recent years, and Zuckerberg had also expressed an interest in acquiring WhatsApp.

So last weekend, as the two men negotiated over a plate of chocolate-covered strawberries, Zuckerberg agreed to nearly double Google’s price.

There is concern that by valuing the number of users above revenue, Facebook is merely inflating another dot-com bubble.

But by the unique logic of Silicon Valley, Facebook may have in fact negotiated a good deal. WhatsApp has grown faster than almost any company in the history of the web, faster than Facebook itself. It is adding a million users a day and is on track to reach a billion before long.

And while WhatsApp has nominal revenue right now — charging users just $1 a year, with the first year free — other messaging services make money through a mix of user fees, advertising and the sale of virtual goods.

“Services in the world that have one billion people using them are all incredibly valuable,” Zuckerberg said on a conference call on Wednesday. “We see a pretty clear trajectory ahead, and we were just very excited to work together on this.”

Facebook, Google and others have been accused of overpaying for unproved start-ups before. Yet these leaps of faith have helped define Silicon Valley’s most successful corporations.

When Google bought YouTube for $1.6 billion in 2006, critics called the search giant crazy. YouTube is now the dominant video platform on the web.

When Facebook acquired Instagram for $1 billion in 2012, it, too, was assailed for a supposedly bad investment. But today, with Instagram thriving and beginning to sell advertising, that deal looks like a bargain.

In WhatsApp, Facebook sees not a trove of patents or a lucrative advertising model but the future of communications — mobile, cross-platform, cheap and international. If the company can increase the number of WhatsApp users and the amount of time they spend with the product, it will theoretically be able to cash in one day. After all, when a product has a billion users, it needs to earn only a few dollars a year from each of them to be a robust business.

“As staggering as $19 billion seems as a number, when you think about the size of the market at stake, and the impact it might have on the firm’s long-term trajectory, you can understand the price,” said Josh Lerner, a professor at Harvard Business School.

For the price it plans to pay for WhatsApp, Facebook could have acquired companies like United Continental, Best Buy or Sony. Instead, it spent the money — $16 billion in cash and stock plus up to an additional $3 billion in restricted stock units — on a fast-growing text-messaging service with nominal revenue. Facebook’s stock was up 2.3 per cent on Thursday as investors endorsed Zuckerberg’s philosophy of attracting users first and worrying about profits later.