Facebook – Goodwill hunting.

No change at WhatsApp means a thumping goodwill write-down.

• Speculation is rife with regards to why Facebook was willing to pay $19bn for WhatsApp and how it will earn a positive return on that investment.
• The market’s view is that data from chats will be collected and used to sell advertising while RFM believes that WhatsApp will follow LINE and KakaoTalk into mobile gaming.
• I believe that taking WhatsApp into the critical segment of mobile gaming is the only way by which Facebook can hope to earn a decent return on this investment.
• However, both Facebook and WhatsApp have been adamant that nothing is going to change.
• Personal data will not be harvested from chats and WhatsApp will not be going into gaming.
• Instead, Facebook aims to grow the WhatsApp user base to 1bn users and not worry about monetisation.
• That leaves investors with one revenue stream from this asset which is the fee that users pay to use the service.
• This is $1 per user per year but collection of this fee is not rigidly enforced.
• This is why I believe that WhatsApp’s revenues are $0.50 per user per year in the best instance.
• I think that WhatsApp can reach 1bn users with Facebook behind it but growth beyond this will be very slow as Facebook’s own user base is showing.
• As the user base grows, I am sure that ARPU will also fall but, for the moment, I will stick with using $0.50 per user per year.
• 1bn users would translate into $500m in revenues on an annual basis.
• If I assume 90% margins this translates into cash flow of $450m.
• If I further assume that the user base grows at 4% for ever and that Facebook’s cost of capital is 10% then WhatsApp is worth $7.5bn.
• This may sound absurd, but these are exactly the calculations that Facebook’s finance department will be obliged to carry out when it carries out its annual goodwill impairment tests in the years to come.
• To justify $19bn these revenues will need to grow at 7.7% forever which everybody knows is impossible.
• Hence, without another clear source of revenues, Facebook will be forced to take a goodwill write-down in excess of $10bn.
• This is why I am certain that, behind closed doors, there is a substantial monetisation strategy which includes a move to gaming as well as user chat data collection.
• This strategy, even if it is not public, can be applied to the goodwill impairment tests at the end of each year and this is how I believe that Facebook intends to avoid an embarrassing and expensive hit.
• Once they are in the door and hooked on the service, then they can be safely monetised as they will not want to lose the service.
• There is no such thing as free internet but users need to have hope in order to keep them signing up.