Mallinson: Facebook pays over-the-top for WhatsApp

Keith Mallinson

There is a lot to play for and at stake in mobile communications. It is among the very largest industries with operator revenues of $1.16 trillion (€812.4 billion) in 2012, according to GSMA Intelligence.

Notwithstanding some overlaps and double-counting, revenues in mobile applications, content services and advertising are relatively small, in the double-digit billions of dollars, but are growing rapidly. Facebook is paying top-dollar to acquire WhatsApp to exploit over-the-top opportunities there. With already 450 million (13.2 per cent) of the world's 3.5 billion mobile subscribers using WhatsApp for messaging, and despite puny revenues of only $20 million in 2013, this challenger is well-positioned as a potentially significant commercial disruptor including introduction of voice services, as recently-announced, at the Mobile World Congress trade show in Barcelona, Spain.

But far from betting the farm

There is a winner-takes-all (or majority) tendency with various ICT platforms. For example, leaders Intel in PC microprocessors, Microsoft in PC operating systems and Google in search and smartphone operating systems dominate globally. But leadership can be precarious and very temporary. Positions can rapidly be overturned, as illustrated by the demise of Netscape in browsers, MySpace in social networking, BlackBerry and Nokia in smartphones. 

Given signs of market saturation and customer fatigue with Facebook, while the company's valuation continues to ride high, it made sense to wager a lot to secure what is probably as good a contender as any to be the leader in undercutting operators in their major cash generators--voice and messaging with SMS and MMS. The $19 billion being "paid" for the acquisition includes $12 billion in Facebook stock and only $4 billion in cash. The founders and employees of WhatsApp, about 55 in total, will be granted restricted stock worth $3 billion that will vest over four years after the deal closure. In total this represents around only 11 per cent of Facebook's $178 billion market capitalisation. That Facebook's market cap is probably no less inflated than WhatsApp's mostly stock-based purchase price provides significant justification for this reasoned gamble with an expanded beachhead in mobile for Facebook.  For example, Facebook's enormous market cap compares to only $42.3 billion in U.S. digital advertising spending in 2013.

The acquisition is one of the preciously few opportunities that can even provide hope Facebook's market value might be sustained in its desperate attempts to remain relevant and significant in mobile. These look like bubble valuations to me, but what were the alternatives for Facebook's management?  And, perhaps rival suitors were also willing to pay a very high price.

A great deal for free

On the face of it, the market in voice and messaging, which still accounts for the vast majority of the $1.16 trillion in mobile operator revenues is much larger than that in digital advertising Facebook currently addresses; but only a very small percentage of this figure could ever be captured by OTT challengers. And, despite continuing growth in smartphones, addressable market revenues are declining.

Operators are unable to resist the onslaught from OTT service providers who ride for free on their networks, so operators are changing their business models in response. In the quest to grow the market with new services and compete with their peers, operators are investing heavily in rolling out mobile broadband networks at great expense in spectrum fees and in capital expenditures to renew technologies, expand coverage and massively increase capacity.

With applications and OTT services providing no fees to use the networks, operators are increasingly making their revenues on access fees and usage-based data charges rather than per minute or per message-based pricing. In competition with the OTT players, voice and messaging services have become extremely competitive with prices being driven down to marginal costs, which are very low. For operators, the question is to what extent they tolerate the market share loss from price-based OTT competition in voice and messaging while still, temporarily, milking the majority of the market, versus dropping prices (right down to zero per minute or message in some cases) to preserve market share and deter competitors. Many operators have already moved to bundle free text messaging in "data"-oriented service plans, and voice is headed the same way.

Monetising data usage has therefore become paramount for operators. In his keynote interview at the Mobile World Congress recently, Facebook CEO Mark Zuckerberg said that certain operators saw, within just three to four months, doubling of mobile data subscribers by providing free access, to Facebook and other services such as Wikipedia and weather information, with "zero-rated" data.  However, when Facebook COO Sheryl Sandberg reportedly asked Vodafone CEO Vittorio Colao to zero-rate content, he rebuffed her, saying it did not make sense. Network transport costs per gigabyte of data traffic transported are reducing by orders of magnitude with deployment of new network and handset technologies from 2G to 3G to 4G and beyond, and with increasing scale, but profitable monetisation is essential to justify and sustain these vital investments.

In voice calling and messaging, multiple-SIM ownership and SIM-swapping indicates consumer readiness to switch among operator services to reach different people and to save money. With a billion or so smartphones in service, WhatsApp is already well penetrated, but with modest growth potential as the base of smartphones increases several-fold to around the 3.5 billion in subscriber penetration for all mobile phones today. On the other hand, there are other well entrenched alternatives to operator voice or SMS/MMS including Skype, BlackBerry Messenger, Twitter and SnapChat. Markets are also forked, with national services including Sina Weibo and TenCent's WeChat in China and others elsewhere. With free or nearly free services, consumers happily become part of the subscriber count for several different services, with their usage shared equally or unequally among these.

A long shot gamble or a hedge?

If winner-takes-all prevails in voice and messaging on smartphones, and WhatsApp owned by Facebook retains the crown, business might conceivably provide a return on the $19 billion price Facebook is paying for WhatsApp. But it is neither likely that dynamic will prevail over significant diversity in OTT voice and messaging providers, nor anything like certain that WhatsApp would become the sustained leader if it did. However, the acquisition might just keep Facebook sufficiently at the forefront in mobile, and for long enough, to position it to lead with the next big thing in mobile if and when that comes along. That makes WhatsApp as much an insurance policy as a gamble.

Keith Mallinson is a leading industry expert, analyst and consultant. Solving business problems in wireless and mobile communications, he founded consulting firm WiseHarbor in 2007. Find WiseHarbor on Twitter @WiseHarbor.