Facebooks Acquisition of WhatsApp: The Rise of Intangibles (A):

Susan Shaw had a number of diverse interests. In addition to a rising legal career, she loved whitewater rafting, gourmet cooking with friends, Broadway musicals, volunteering at the local homeless shelter, and investing in the stock market. It was the investing pursuit that occupied her attention this cold and rainy Saturday morning. On her desk, she had several pages of Facebook Inc.s 2015, 2014, and 2013 financial statements that she had had the foresight to print out earlier in the week at the office. She was intrigued with the idea of investing in a company that sure seemed like an investment winner.

As she perused the financial statements, her normal starting point for learning more about the performance of a company, the first thing she noticed was that in the 2014 financial statements there were some huge differences from the 2013 statement for a number of line items, including Total Assets, Goodwill, Additional Paid in Capital, Revenue, Net Income, and Net Cash Used in Investing Activities (see Exhibit 1). The reported dollar amounts for many of these items, sprinkled across the 2014 balance sheet, income statement, and statement of cash flows, had more than doubled. I wonder whats up, she mused. I guess Ill need to delve into the details to find out. It sure seems unusual that a company could double in size in just one yearthere must have been a merger of some sort. Indeed, a simple Google search of Facebook and 2014 mergers turned up a number of hits. Eight of the first ten search listings referred to the company, WhatsApp Inc. Her interest was piqued, so she poured another cup of coffee and began her methodical review.

Facebook, Inc.:

Historically, February 4 was noteworthy for a variety of reasons. In 1826, the James Fenimore Cooper classic, The Last of the Mohicans, was published and remains popular to this day. Almost 100 years later, in 1922, Ford Motor Company purchased Lincoln Motor Company for $8 million in one of the most high-profile corporate acquisitions up to that time. In 1938, Disney released the pathbreaking and enduring animated movie, Snow White and the Seven Dwarfs. The first electric portable typewriter was offered for sale in Syracuse, New York, on February 4, 1957. Also on that day, in 1998, Bill Gates, of Microsoft fame, was unceremoniously hit in the face with a cream pie, by a local hooligan, upon his arrival for a business meeting in Brussels. And on February 4, 2004, Mark Zuckerberg, then a 19-year-old Harvard college student, quietly launched Facebook from his dormitory room.

Shortly after its launch, Zuckerberg was asked what Facebook was. He replied:

Facebook is] an online directory that connects people through universities and colleges through their social networks there. You sign on, you make a profile about yourself by answering some questions...[provide] contact information [and] anything you want to tell [such as] what books you like, movies, and most importantly, who your friends are. Then you can browse around, see who peoples friends are, and just check out peoples online identities and see how people portray themselves and just find some interesting information about people. When we first launched, we were hoping for 400 or 500 people [and] who knows where were going nextmaybe we will make something cool!

From Facebooks 2014 Form 10-K available online through the Securities and Exchange Commission (SEC) website, Shaw read:

Our mission is to give people the power to share and make the world more open and connected...Our top priority is to build useful and engaging products that enable people to connect and share through mobile devices and personal computers. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest friends to the public at large, and stay connected everywhere by accessing our products...Our business is characterized by innovation, rapid change, and disruptive technologies. We face significant competition in every aspect of our business, including from companies that provide tools to facilitate communications and the sharing of information, companies that enable marketers to display advertising, and companies that provide development platforms for application developers. We compete to attract, engage, and retain people, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with Facebook, and to attract and retain highly talented individuals, especially software engineers, designers, and product managers.

Shaw recalled that it had not been so long ago that there had been quite a buzz about Facebooks initial public offering (IPO). Indeed, with much anticipation and excitement, that IPO had taken place on May 18, 2012. By the end of that day, $16 billion had been raised, indicative of a total market capitalization for the company then of just under $91 billion. The following few years were witness to that corporate valuation rising and falling, at times quite dramatically. In spite of those fluctuations, however, the general trajectory for Facebooks valuation was positive, as were many other aspects of Facebooks place on the business landscape.

Fast forward. Shaw wondered what other current Facebook-related information she could easily obtain. Among other things, she found that as of May 4, 2016, Facebooks market capitalization was just over $337 billion. In concert with that valuation, and according to Forbes magazine, Zuckerberg was the sixth wealthiest person in the world, with a net worth of just over $51 billionand by far, he was the youngest person on the Forbes list of the 100 wealthiest people in the world. Moreover, the Facebook global brand had risen from 69 in Interbrands 2012 ranking to 23 in its October 4, 2015, ranking (its brand value was estimated at slightly over $22 billion). And the initially hoped-for 500 users had morphed into more than 1 billion daily active users during March 2016, supported by more than 13,000 Facebook employees. Without a doubt, not bad for something cool to have emerged in just 12 short years.

WhatsApp, Inc.:

As a natural extension of her inquiry into Facebook, Shaw began learning about WhatsApp. Five years after the birth of Facebook, Jan Koum and Brian Acton had founded WhatsApp. They were near fanatical about developing an instant messaging system for smartphones focused on speed and reliability, eschewing the typical advertising links and add-ons. In fact, at one time a hand-written note on [Koums] desk read: No Ads! No Games! No Gimmicks! After tapping into the SECs 10-K website again, Shaw read:

The Company provides a cross-platform communication application, which allows users globally to exchange unlimited text and multimedia (audio, video, and photo) messages without having to pay for short messaging service (SMS) fees. Users can communicate through one-to-one messages, create groups, or broadcast lists. Currently, WhatsApp supports iPhone, BlackBerry (and BB10), Android, Windows, Nokia S40, and Symbian platforms. Users can send messages via WhatsApp application using existing mobile data connections or Wi-Fi. The Company is headquartered in Mountain View, California. The Company provides messaging services through the WhatsApp Messenger application. The users pay a subscription fee for the messaging service that the Company offers in certain countries. The Company derives revenue from two sources: (1) term subscription revenue, which is comprised of subscription fees from users utilizing the WhatsApp messaging service through their mobile devices over a subscription period of one year, three years, or five years; and (2) perpetual subscription revenue from users utilizing the WhatsApp messaging service on mobile devices that have perpetual subscription periods.

Several recent news articles that Shaw also came across provided some updates. Until recently, the user subscription fee was only $1 a year. Because most users were outside the United States, in January 2016, WhatsApp announced it would drop even that low fee and explore ways that businesses can interact with the mobile messaging services users. According to Koum one of the co-founders, the subscription fee really doesnt work that well in a lot of countries, and we just dont want people to think that their communications with the world will be cut off. Many users dont have a debit or credit card to let them pay for the service. After being acquired by Facebook, WhatsApp remained adamant that it would not move to a model relying on third-party ads to compensate for the loss of annual revenue fees. It remained an open question of how best to monetize the one billion monthly active users who send 42 billion messages and share 1.6 billion photos a day. And undergirding this huge amount of activity was only a handful of engineersabout 50.

The Acquisition:

On February 19, 2014, almost 10 years to the day since Facebook was founded, the company announced it had reached a deal to acquire 100% of WhatsApp shares for $19 billion. Shaw was struck by the unabashed, immediate exclamations coming from the business press describing the purchase price as insanely high, an eye-watering amount, a stunner, staggering, jaw-dropping, and a deal of historic proportions. At that point in time, WhatsApp was unprofitable (Exhibit 2), had a total of 55 employees, 450 million monthly users, 1 million new users signing on per day, no ads, no platform for games, and a $1 annual fee after a free first year of use. Despite these mixed indicators (i.e., unprofitable but lean in size, miniuscule revenue stream but impressive user growth), the acquisition price was indicative of a market capitalization for WhatsApp that exceeded that of such well-known and well-established companies as American Airlines, Ralph Lauren, Campbell Soup, and Coach. As another point of reference, Facebook had purchased Instagram two years earlier for $1 billion; Yahoo! had purchased Tumblr for $1.1 billion in 2013; and Microsoft had paid only $8.5 billion for Skype in 2011. The Facebook deal to acquire WhatsApp was epic by all accounts, but was it a stroke of genius by Zuckerberg or was it a high-priced roll of the dice for possibilities, ideas, and access to a handful of talented individuals?

READ the above case before answering the question below.

Question 1:

What strategic moves were perhaps fueling Facebook's interest in acquiring Whatsapp?