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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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