Is WhatsApp Really Worth $19 Billion?

I have already posted two commentaries on Facebook's acquisition of WhatsApp for $19 billion:  Peter Schiff: What's Up With WhatsApp? and Facebook and WhatsApp: The Worst Deal Since Countrywide. Both writers take a very negative view of the acquisition. And, indeed, from an outsiders perspective, the acquisition looks positively insane.

But an outsider may not under stand the essence of the deal. Let us take a look at a pre-internet businessman I knew, who appeared to be making insane acquisitions of small stock market newsletters, to understand dynamics of a deal that would be difficult for an outsider to recognize.

My businessman acquaintance would approach small circulation stock market advice newsletters writers and buy their newsletters for prices that the writers thought resulted in a huge over payment.

The deals would go something like this.

The businessman would approach a small monthly newsletter writer who had, say, 1,000 subscribers and had a conversion rate on his subscriptions of only 10%. The conversion rate is the percent of trial subscribers that convert to annual subscribers.

A conversion rate of 10% is very low and was probably due to the poor writing skills of the writer or some very bad stock pick advice---or both. But the businessman I knew had a newsletter that could convert most subscriptions at a rate of 20%. So he would approach these small time newsletter writers and offer them an unbelievable price for their newsletter.

Let's say our 1,000 subscriber newsletter writer charged $100 for an annual subscription. With a 10% conversion rate that meant that 100 subscribers would convert to annual renewals, for revenue of $10,000. Let's say the cost of printing and postage for each issue of  newsletter was 50 cents. So over a 12 month period, the cost was $6.00 or a total of $600 for all 100 annual subscribers. So net income was $9,400.

The businessman buyer would try and buy the newsletters as cheap as possible, but he would be willing to pay up to $20,000 for a newsletter such as the one above. Got that? Some guy who is toiling away at a failing newsletter was being offered more than twice the annual income for the newsletter. Most failing newsletter writers jumped at the deal.

But, the newsletter buyer had a conversion rate for his own newsletter, that he would roll the acquired newsletter into, of 20% and so he would ended up generating much more income than the failing writer. He would show annual net income of approximately $19,000. So he would have significant profits one year out. It looked like a pretty insane deal to a semi-making sense deal when viewed from the perspective of an outsider to offer the failing writer so much money. Yeah, the deal broke even after a year,but it wasn't a super deal or was it?

In fact, for the businessman buyer, it was an a incredible deal, something an outsider wouldn't be able to detect. The secret was that the newsletter business was of only secondary interest to the businessman buyer. He was really after the subscriber lists--all of them trial subscribers and converted subscriber. With phone numbers, he could sell each and every one of those names to stock brokers, on a first time basis for $5.00 per name. And after it became a used name, he could sell  it 5 more times over the next year for $2.00 per name. Got that? He was generating an additional $15 per subscriber name.

In other words, the deal to an outsider, which looked like break-eve would only occur after a year, was actually making a cool $15,000 off of those 1,000 names the first year. The businesman was almost doubling his money in the first year of the purchase. If you were an outsider, it would be very difficult to know this was going on.The newsletters sellers never understood what was going on. From an outsider perspective, the deal didn't look as immensely profitable as it really was.

Something of the same might be going on with Mark Zuckerberg's acquisition of Facebook. There are some roll the dice businessmen, who make an acquisition and hope it works out. Maybe Zuckerberg is playing that game, but he really doesn't strike me as that type. The smart businessmen, when they make an acquisition are not rolling the dice, they know exactly how they are going to make tons of money from an acquisition.

WhatsApp, to an outsider like me, appears very vulnerable. It seems their business is nothing more than an advanced text messaging service that could be wiped out by telcom companies restructuring their payment services for text messaging. But we don't know what the insider perspective is. Is WhatsApp coming out with a more advanced app that will eliminate the concerns of telcom competition? WhatsApp has 400 million users, does Zuckerberg have plans to market something to them?

How this acquisition plays out over the next couple of years is going to be fascinating to watch. Only after that time will we really know Whats Up with WhatsApp.Only after that period will outsiders be able to answer the question, Is Zuckerberg a skilled businessman or an idiot?