First, I would like to put 19b in perspective. It is a large number and we have very bad intuition for it. Some benchmark helps. See this excellent comparison.
I am kind of old school and I always use a cash flow model as a benchmark (Though I think it gives very very crude estimates, since the result is purely assumption-driven, but it does give good sense of what assumptions are needed to justify a result. Also, it gives an anchor).
So We need to consider two scenerios: 1)what will be the annual income of facebook if it buys whatsApp $Y_t$ 2)what will be the income of facebook if it buys whatsApp $Y_t'$ Then we need to consider the differential of $\Delta Y_t=Y'_t-Y_t$. As a very crude benchmark calculation, let us hold $Y_t$ and $Y'_t$ fixed and thus $\Delta Y_t=\Delta Y$. When we apply the annuity principle to find what is the value of the discounted present value of all those differential income $\Delta Y$.
\[
NPV=\Delta Y/r
\]
where $r$ is the interest rate.
If we consider an interest rate of 5 percent (risk -adjusted), then it means that the annual income differential needed to justify this purchase is 1 billion usd. That seems awefully large, as the net income of facebook in 2013 is only 1.5 billion.
When it come to tech stuff, we often believe the old rules do not apply. It is the ideas! This time is different! I regard this as nothing but bullshit. The earliest innovation that drives much excitement is the South Sea Bubble in Britain, and the Mississippi bubble in France. They were wonderful financial innovation that really could be very beneficial. The railroad bubbles seem to be got forgotten as well. We are not talking about worthless craps--like many in the tech bubbles. We are talking about things of value, and people just get over-excited. Nothing more, nothing less.
Financial Times has a pretty interesting analysis.
If I have to speculate, the tech industry contains lots of hype. There was a time it created lots of value, and truly made things better. Skype was a wonderful start. But later things just get boring. It is just some marginal incremental improvements whose value seldome justifies the extra cost. (like iphone's first appearance was great and a couple of improvements were good, but the later innovations have run out of steam). I think the demand is now sustained more by commercial manipulation that exaggerates the differences, and prey on people's catching up with the latest mentality. This is not sustainable. There is much to catch up, and smartphones will not always be on the list.
It's really nice to get your perspective on this. I was thinking about WhatsApp yesterday and find your model on the value that WhatsApp needs to bring to Facebook insightful. I feel that the valuation appears justified on the following terms (but aren't really justified):
ReplyDeletea. WhatsApp has about 500m users, it recently rolled out price of $1/user-year, that gets us 500m for annual revenue, suppose no cost then it takes 40 years to get the returns back. Two things (1) it's growing very fast (2) WhatsApp has not explored other revenue-generating options like Emoticon and games, which are already well-tread territories by WeChat and Line. That valuation does not look outrageous on these terms as it does when I just look at the 20b number.
b. Mobile carriers are losing out 33b a year globally because of Internet messaging services. Suppose WhatsApp captures 20% of the market share, that’s 6.6b annually. Suppose WhatsApp can monetize 20% of that revenue lost by mobile carriers, then that’s 1.32b a year.
c. Companies like Instagram, King Games (Candy Crush), and OMGPop (Draw Something) look like fad, but WhatsApp does not. It offers an almost identical experience to text messaging and is built to replace it because of cheaper prices. Text messaging probably won't just go out of fashion like Draw Something did.
d. Judging by the market cap of Tencent, WeChat is valued similarly.
e. What I do not find to be a convincing reasoning behind the valuation of WhatsApp is the price per customer count. Apparently Google is currently valued at 200+ USD/customer. Twitter, Facebook, and Pandora around 100 USD/customer. And Yelp, Zynga, WhatsApp, and Instagram around 50 USD/customer. It makes numeric sense, but I think these different services are able to generate very different profit per customer based on their revenue model and ad-display capability. Customer stickiness to the services are also very different.
About tech industry in general, it is really valued pretty outrageously. I think the valuations of companies like WhatsApp and Netflix are justified if everything goes extremely well but that of course is likely not to be what happens. On the other hand, past tech company stock price revisions like those of Zynga and Groupon did not trigger a lot of industry wide fluctuations, so I am not very certain what would potentially trigger a second tech bubble burst, should that happen.
Thank you for bringing your insights! here are how I feel:
Deletea. we need to discount future earnings, so 40 years will not make it back. also, as you said you assumed no cost, so if we take into account the cost, the operating profit would probably be much lower than $1 per person, since each transaction will induce costs, independent of the fixed cost of the firm (which might not be too big given they only have 55 employees). trees do not grow to the sky, and the user base will not grow indefinitely, we could not extrapolate current growth into future. Firms that are growing very quickly are more likely to be the ones that are capturing its possible market very quickly, and there might not be much left.
b.mobile carriers are losing 33b in REVENUE. even if WhatsApp captures all that, it will not be capturing 33b in REVENUE because an important reason is cost, thus, WhatsApp could only capture the market via lower lost, which means lower revenue, which means even less profit. so I would say about 0.5 b sounds right. Btw, this overlaps with the same calculation in part a, calculating customer value.
c. i think the eagerness to engage in as much of social networking as possible has some fad element. I installed wechat, facebook, twitter, linkedin, and all those stuff enthusiactically in the beginning, and now am more or less out of it. also, people might stick to WhatsApp, but it is not clear how much value one can put on each customer.
d. I do think wechat or Tencent is over-valued. I think the price of chinese stocks are just not right. not to mention it is chinese tech companies.
e. finally, I think for things like facebook, wechat, whatsapp, people are kind of addicted to it and they know it. they would want a self-control mechanism to stop them from using it. I think charging a price would often do the trick. so this casts doubt on how much one can monetize those things....
i do feel there is sort of bubble going on. it is kind of depressing that the recent two bubbles (finance and tech) are not very productive bubbles like railroad. after all a bubble diverts lots of resources to a sector, and if the sector is productivity-enhancing the positive externatlity might mean it is a growth-enhancing bubble. but I really see little value coming out of whatsapp or facebook. maybe I am too old school to see new values.
About the companies in the tech industry now, I do feel that the incremental changes on phones is not impressive anymore, and the same holds for social networks. However this may be because innovations in these fields have largely finished, like those for personal computers did more than a decade ago.
DeleteFinance for example might be a promising area in the next few years. Square and Venmo and soon WeChat will allow ubiquitous payment. 余额宝 makes complicated investment instruments more accessible to and popular among the average person, etc.
I'm planning on reading a book or two on bubbles soon and will let you know if I have any other thoughts on this afterwards. But about the stock market I'm not optimistic.