The last week or so has been filled with news of the surprise announcement that Facebook will be acquiring the mobile messaging service Whatsapp for $19bn consisting of $4bn in cash, $12bn in Facebook shares and a further $3bn in restricted stock that management will receive over a 4 year period. Oh, and that’s in addition to Bloomberg reporting Whatsapp’s founder Jan Koum will also get a board seat at Facebook. The key question for Facebook investors is whether this was a good move & for everyone else – how to learn from it.
What is $19bn worth nowadays?
I always remember an equity analyst telling me that most investors ‘know the price of everything and the value of nothing.’ It’s something that has stuck me, and when put in the context of Facebook’s $19bn acquisition of Whatsapp, one has to wonder whether it really is as valuable as the market cap of Marriot International Hotels ($15bn), which owns luxury hotels and access to properties around the globe using its brand. Alternatively, there’s Ferrari ($6bn), the UK retailer Marks & Spencer ($15bn) and even the global icon Tiffany & Co ($12bn). The Drum has a good round up of how mind-boggling this is. All of the listed companies have real revenues and profits that run into many millions, if not billions of dollars. Mark Zuckerberg the CEO and founder of Facebook believes Whatsapp is worth more than the $19bn Facebook is paying. With Facebook stock down less than 1% in the last 5 days and up 26% year to date, it seems as though investors are not phased by the price tag being paid for their latest acquisition. Here’s the chart courtesy of Google Finance:
Going back to value
Zuckerberg isn’t alone in believing Whatsapp is worth the money, even David Rubenstein the CEO of famed private equity firm Carlyle Group reportedly believes the same. Ultimately though, shareholders need to realise that their funds have been used to acquire a company which should (in theory) provide a return on their equity. The problem with Whatsapp though is that it doesn’t have significant revenues; the business model is based on having roughly 450 million users a proportion of whom will eventually pay an annual fee to continue using the service after an initial 12 months of usage having downloaded the free app on their smartphone. Back in the day when Blackberry was the Apple of smartphones, Whatsapp was a great way for users of the Blackberry Messenger (BBM) service to get similar chat functionality with their iPhone friends. Since then, iPhone has launched an iMessage service while Google has Gtalk, oh and there’s Skype too which even includes free wifi voice and video calling. Most of my friends who were the early adopters of Whatsapp have since stopped using it and moved onto the free applications, afterall- why pay when there are free alternatives? This makes me question the entire business model Whatsapp and in turn the future earnings gained from it. The whole things reminds me of Pets.com – you probably don’t know of that company because it went from raising $80m in an IPO back in the year 2000 on management promises of hundreds of millions of dollars in annual revenues only to go bankrupt 268 days later. According to Wikipedia $300m worth of investment capital evaporated with the company’s failure.
The silicon valley playground & investors’ hard-earned cash
Last year, I actually met with the partner of a Silicon Valley venture capital firm that was among the early investors in Facebook. I also at the same meeting bumped into one of the key venture capitalists that backed Dropbox. The sense I got from these guys is that high stakes come with the territory of technology and that for the (many?) losers, one moonshot investment will make up for it, so entrepreneurs should dream big. That’s all motivating stuff for the management team of a start-up but as an investor myself I had to ask myself whether I wanted to gamble on such potential moonshots. Having worked with many blue-chip clients, the scary thing is that even at spectacularly large companies – CEOs have a tendency to spend cash as if they need to prove themselves. Spending cash on the hopes of a moonshot or worse, just to satisfy an ego is not how I would want my hard earned cash to be spent as the business owner. In many ways this is why I have much respect for the late Steve Jobs and his new CEO Tim Cook for resisting the urge of large acquisitions just because Apple can. Apple’s management has maintained this position against much criticism but they’re absolutely right to in my opinion; just look at the colossal failure from the $12bn Google acquisition (and now divestment) of Motorola.
I’m not against large acquisitions; Warren Buffett has made some terrific deals, such as buying Burlington Northern Santa Fe for $26bn. The difference is his businesses have real earnings that are based more on market fundamentals than hopes and dreams.
Investors are responsible for their cash
While members of the board have a fiduciary responsibility to act in the shareholders’ best interest, the problem with bad acquisitions come down to human nature, not the intelligence of the people making the decisions. Investors need to be responsible for the stewards they elect to manage their cash and their company’s resources effectively. In essence it all comes down to selecting the best capital allocators. Fortunately, there are two things that can help an investor ensure capital is allocated effectively when making an investment: select managers who have a good track record of capital allocation (or at the very least avoid those who have a bad record) and invest in companies that prioritise returning cash to the business owners after all expenses have been paid. These are typically dividend paying stocks with a consistent track record of buybacks / dividend increases.
There are a few reasons why I prefer dividend-paying companies. One, I like the fact that I’m getting a share of company profits that should grow each year (it’s not much fun investing in a company if you can’t enjoy the profits) but more importantly it forces management to be disciplined in operating the business to serve shareholders. Without a large reserve of shareholder cash, Management adopt a culture of frugality where only the most promising projects are pursued backed by a solid investment case. Rather than chasing moonshots, they have to make a focussed investment on a few good ideas and then work relentlessly to deliver against plan. As a shareholder, if those ideas translate into tangible earnings then the business will grow and as it does, so will the ability for management to pursue additional capital projects.
Today, Facebook has a price to earnings ratio that exceeds 100. That means for every dollar an investor puts into the company, they can expect Facebook to generate an additional $1 in earnings after 100 years. Those same investors have just purchased Whatsapp.
I know which camp I’m in. Tiffany & Co. or Marriot anyone?