Friday, February 21, 2014


"Why? WHY?"  That's the question many people are asking themselves in the light of Facebook's historic $19B acquisition of instant message maker WhatsApp.  I must admit I was puzzled myself at the price tag, but found no shortage of Internet pundits (on Forbes and CNN Money, to name just two) willing to justify the cost based on a number of factors.

Personally, I prefer quantifiable measurements.  And while my weapon of choice is typically financial metrics, such as NPV, IRR, and ROI, when it comes to M&A targets of this type where the primary driver is the size of the acquired company's user base, I switch to the advertising metric Cost per Thousand (users), or CPM for short.  ("M" is the Roman numeral for "thousand.")

CPM rates are typically used for things such as online advertising and name list rentals (i.e. when you register on a website your information is rented to other companies who can specify that they want a pool of demographic data that meets certain, very specific criteria).  Because its roots go back to advertisements in printed publications (remember those?), its use is ubiquitous and provides a consistent framework with which to analyze the quality of the acquisitions made for reasons of increasing one's user base.

Looking at the CPM of this acquisition in the context of other acquisitions made, presumably, for the same reason you see nothing interesting.

This, in and of itself, is interesting because this is the first metric I would have expected the company to evaluate when discussing a list of potential M&A targets.  (On a side note, Microsoft's acquisition of Skype is eye opening when viewed from this perspective, so it's no wonder that the acquisition is generally viewed as a failure.)

Since all of these companies bring substantial amounts of revenue from advertising, and advertising is used to drives sales, I decided to look at this from the revenue perspective.  However, this requires some context in order to properly evaluate the numbers, and since the king of all online shopping is Amazon that's what we will use to establish this context.

In July 2012, the website Internet Retailer quoted a figure from eDataSource saying that the average Amazon order value in June of that year was $47.31.  While this figure was derived from the examination of only 30,000 orders (vs. the 164 million paying customers in total that it had as of an article written in March 2012), it is statistically relevant enough to use it as the basis for our analysis.

The reason why CPM's usage as a metric to determine the quality of the purchase of advertising over the years is because "eyeballs" can be directly correlated to purchase decisions of the owners of those eyeballs.  Get more eyeballs and you get more revenue from purchases made.  But even though Internet based advertising should, in theory, allow a researcher to get a very accurate revenue figure based on advertising (psychological aspects of purchase making notwithstanding) this requires a degree of transparency that advertisers are typically not willing to share.

To assist, a second metric was developed way back when Yahoo was king of Internet advertising (remember those days?) in the late 90's.  That metric, Click-through Rate (or CTR), allows a copy to reasonably predict how well their advertisements will, at the very least, translate to a visit of their website.  2% is considered to be a very good CTR, so I decided to use 1% for my purposes.

Using these two figures, we can get an idea of the potential revenue that Facebook can expect, assuming those 450mm users on WhatsApp are not existing Facebook users.  This is highly unlikely, but in the absence of hard data quantifying the amount of overlap, I'll assume the best case scenario of 0% overlap.

The subheadings under Potential Revenue list the number of purchases per year using the $47 per order figure from Amazon to calculate revenue.  Assuming 10 purchases per year, WhatsApp (in the hypothetical base case scenario of 0% overlap) brings in a substantial amount of revenue.  But it is still puny when compared to the purchase price.

So why did Facebook buy WhatsApp for that amount?  Maybe those Internet pundits aren't so far off after all, listing reasons such as the typical demographic for WhatsApp being the younger age group that Facebook is losing profusely or the supposed $10B offer that Google made to buy the company, a move that Bridge players will recognize as a preemptive bid to shut out the other players.

What's your take on this?  Leave a comment!

As a final note, during my research I found an interesting discussion of mobile based instant messaging and its impact on telephone companies.  Bloomberg quotes research from Ovum that states phone companies lost $33B on texting fees to free instant messaging applications like WhatsApp, and says that number will balloon to $54B by 2016.  Without access to the underlying research data it's hard to say the accuracy of the analysis since large metropolitan areas (like the greater NYC area) often have high degrees of competition resulting in unlimited, free texting, but the number is still substantial enough that the carriers cannot avoid it.  Look to this to be an untapped area to be exploited by Verizon, AT&T and others in the coming 12- to 24-months.

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