Anorak News | Paying $19 Billion For WhatsApp Will Kill Facebook

Paying $19 Billion For WhatsApp Will Kill Facebook

by | 20th, February 2014

THIS will sound a little contrary, but bear with me: the purchase of WhatsApp by Facebook for $19 billion contains the seeds of what’s going to kill Facebook in the end. For it’s a sign that it’s both relatively easy to start a new messaging application and also that Facebook is going to have to keep buying up the new ones as they appear. And that way lies eventual bankruptcy.

The deal in essence is as follows:

The two men have known each other for years, but only began discussing the deal 12 days ago. They settled it for $19bn, including $4bn in cash, $12bn in Facebook shares and $3bn in restricted stock awards for WhatsApp’s founders and employees.

OK, this gives Facebook access to the 450 million people that use WhatsApp. Hurrah! we might think. but here’s the next part of my argument:

Instagram was very small at the time – it had just 11 staff – but the photo-sharing service had hit upon a successful formula. It was growing rapidly, and Zuckerberg knew it would become a potential threat to Facebook if he didn’t swallow it up first. The WhatsApp deal is no different, other than for its order of magnitude. Facebook has agreed to pay $19bn for the instant messaging platform, partly for access to its users, but mostly to ensure it doesn’t get hobbled by this very threatening competitor.

And here’s the third part of it:

News broke earlier today that Facebook was buying popular messaging app WhatsApp for $16 billion, and while the social media giant ingesting yet another company is certainly news unto itself, the deal marks what could be one of the most successful venture capital investment deals of all time. Sequoia Capital reportedly invested a mere $8 million in WhatsApp back in 2011 — and while startups commonly raise subsequent rounds of funding amongst several investors, WhatsApp never announced any additional funding. Simply sticking with that initial investor would be striking, but it’s even more arresting in light of the payoff.

The percentage of WhatsApp owned by Sequoia has been kept under wraps, but sources tell us it lands somewhere between 10 and 20 percent — meaning Sequoia could be reaping as much as $3.2 billion in cash and stock for that initial investment.

So, let’s piece this together. Any time anyone creates a new social media app that looks like it’s going to be successful then Facebook’s Mark Zuckerberg has to at least consider buying it. Because if all the Kool Kids go off and do their social media-ing somewhere else then that core Facebook empire is under threat.

On the other hand we’ve just seen a VC firm make $3.2 billion on an investment of $8 million in a social media app. So there’s not going to be any shortage of money behind the next wave of people who try to build a social media app is there? Which means that in a couple of years’ time Zuckerberg has to do this all over again. And then, again, and again and again down the years. He’s simply got to keep buying all the upstarts. And eventually, even he’s going to run out of money to do so.

The other way of putting this is in more conventional economic terms. In order to make excess profits (this is defined as profits higher than the general cost of capital) you’ve got to have some method of keeping the competition away from your customers. And there’s just no way to do this in this social media space. Thus the plan just ain’t gonna work.

Posted: 20th, February 2014 | In: Money, Technology Comment | TrackBack | Permalink