Facebook announced this afternoon that it will pay $16 billion for WhatsApp, a free messaging application that lets users tap into their phone’s Internet connection to avoid paying hefty text messaging fees.

This note is a daily reminder at the WhatsApp office that reads “No Ads! No Games! No Gimmicks!”  Credit: Sequoia Capital
This note is a daily reminder at the WhatsApp office that reads “No Ads! No Games! No Gimmicks!” Credit: Sequoia Capital

But based on what we know about WhatsApp’s business model, Facebook isn’t doing the deal for the advertising revenue.

Two years ago, that would have been heresy at the social networking giant.

At the time of its IPO, Facebook had a serious mobile revenue problem. It was making essentially nothing from mobile, and yet, an increasing number of its users were accessing Facebook on the phone. Fast forward to today, and now Facebook is essentially a mobile advertising machine.

In January, it hit a major milestone, announcing in its fourth-quarter earnings that it now earns more revenue from mobile than it does from its full Web version. 

So, what’s going on? If not for advertising, why is the social networking giant willing to pay billions for a free mobile messaging app?

Here’s a crack at the logic.

First off, WhatsApp’s founders are religiously opposed to advertising.

“No one wakes up excited to see more advertising, no one goes to sleep thinking about the ads they’ll see tomorrow. We know people go to sleep excited about who they chatted with that day (and disappointed about who they didn’t),” the company explains on its web site. “We want WhatsApp to be the product that keeps you awake… and that you reach for in the morning. No one jumps up from a nap and runs to see an advertisement.”

That’s unlikely to change with the acquisition since Facebook promises to remain hands-off. The WhatsApp’s brand will be allowed to operate independently; its headquarters will remain in Mountain View, CA; Jan Koum, WhatsApp’s CEO and co-founder, will join Facebook’s Board of Directors; and WhatsApp’s core messaging product and Facebook’s existing Messenger app will continue to operate as standalone applications.

So, if not for the advertising opportunity, what else?

It appears to be a defensive move to keep users around the world coming back to Facebook properties and Facebook-owned properties. That’s a current problem that Facebook contends with, and it could get worse in the future. It recently admitted that it saw “a decrease in daily users specifically among younger teens,” which caused its share price to drop 15 percent.

WhatsApp could be a viable solution (even at a cost of $16 billion). Just look at some of WhatsApp’s numbers that make even ginormous Internet sites, like Facebook, salivate.

WhatsApp, which raised $8 million in venture capital in 2011 from Sequoia Capital, has more than 450 million active users, which it claims to have reached faster than any other company in history. Other amazing stats: Every day, more than a million people install the app and start chatting; and the number of daily active users of WhatsApp has climbed to 72 percent. (Clarification: After the company’s initial $8 million round in 2011, Sequoia went on to put as much as $60 million into the company, according to sources at WSJ.)

So, it has the users. But there’s another surprise. It also has revenue, despite having no advertising and providing its apps for free.

After the first year, WhatsApp charges users 99 cents a year for a subscription. That’s peanuts for teens who are no doubt comparing it to monthly subscription fees from telecom providers that can cost 20 times as much for unlimited plans. 

Although it’s unknown precisely how much money WhatsApp is making, a little back of the napkin math shows that 99 pennies could add up to a fair amount of money. If only a small fraction, or 10 percent, of its 450 million monthly users were paying, that’s $45 million a year on a recurring basis.

Even if that estimate is on the generous side, the company could be profitable, too.

WhatsApp is notorious for running lean. It has only 32 engineers, and each one can support 14 million active users, “a ratio unheard of in the industry,” according to Sequoia Capital, which wrote a blog post today about the acquisition.

All-in-all, it’s a compelling buy.

But will it be worth it? $16 billion is a lot of dough. Frequently, WhatsApp is compared to Skype, the Internet service that reduced or eliminated users’ telephone fees. But even still, Microsoft purchased Skype for $8.5 billion from eBay three years ago. Put another way, Facebook just agreed to pay nearly twice as much. It also just paid more than five times as much than it was reportedly willing to pay for Snapchat, another mobile messaging application, which turned down its offer late last year.

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  • http://twitter.com/chrisamccoy Chris McCoy

    Just imagine what can be built on top of and distributed through a network of 450MM+ mobile users around the globe.

    Value this acquisition and all future moves in the social space around the connected network.

    They now own distribution (not TV, newspapers, radio, etc.), discovery, and content creation.

  • Charlesst57

    They are paying $19 billion not $16 billion. Shares worth about $12 billion, plus $4 billion in cash plus $3 billion in restricted stock units (vesting over 4 years). And $1 billion in cash and $1 billion in Facebook shares, in the event the merger doesn’t go through. What’s a few billion difference here or there though…?

  • correct facts

    and they raised ~60M in capital, not 8 as reported. Should do the homework

  • Aaron Mahl

    See, this is where I think Facebook lacks a real edge in this game. You have got brilliant, hot ad networks shooting up in the world like Airpush which would NEVER squander an opportunity to cleverly monetize something like WhatsApp through some appropriate advertising mechanism – probably native mobile ads – but Facebook is already waving the white flag in hopes of not ruffling feathers. I get that FB doesn’t want to piss off fans of the company it just bought, but don’t give up. Innovate. Find ways to make it happen, don’t sit on the sidelines, which is where it sounds like FB is going to be for a while. Explains why FB stock went DOWN in after hours trading once this acquisition was announced. Facebook needs an edge and a fire lit beneath its ass to start innovating like other top ad networks. If Facebook wants to be an ad network, my advice is that they should act like one.

  • Mike_Acker

    time for a federal anti-trust action

  • triciad

    I wanted to clarify the funding situation. WhatsApp did raise $8 million in 2011, but the WSJ reports that Sequoia went on to put as much as $60 million into the company in three rounds. Still, pretty good for a pay-out as this large.

    I think Aaron Mahl brings up a good question. Should Facebook let WhatsApp be true to itself and remain advertising free, or is that ridiculous? Should Facebook be willing to ruffle some feathers at the chance to create an ad network of massive proportions? Would its customers even notice if it was done correctly?

  • Kirby Winfield

    This is a brilliant hedge, they bought 58% growth in DAU’s for 8% of their market cap. And diversified into traditionally tough mkts for FB, and switched on $0.5B in subscription revenue. With the stock so rich this was another great move by FB corp dev. Although my personal philosophy does differ a bit from Whatsapp’s:

  • VL

    I don’t know what this 99 cents thing is about…I’ve used it for years and for free

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