Facebook CEO Mark Zuckerberg justified the $19 billion price tag it paid for WhatsApp by saying that the messenging service is a rare platform that has the potential to reach one billion users. Dennis Berman joins digits with a look at what's behind those numbers.
Not just crazy. Crazytown. Nearly $19 billion for a company that had $20 million in sales last year?
Like nearly everyone, my initial reaction to Facebook's FB -1.31% whopper of a WhatsApp deal was disbelief bordering on laughter.
Then I turned my heart off and turned my spreadsheet on.
I was surprised by what I found. There's no disputing that Facebook paid a huge premium for an untested company in a hotly competitive communications sector. But it takes less than I thought to turn WhatsApp into a decent, if justifiable, business. And that doesn't even count other benefits of scale, strategic defense and Google GOOG +0.62% -rattling that are harder to quantify.
It's still crazy. Just not as crazy as I thought.
If anything, this exercise made me re-appreciate the most obvious and powerful of Web dynamics: Massive global reach at nearly zero marginal cost. Up close, it can be majestic.
Want to see the math? Let's start somewhere far away from Silicon Valley fantasyland. Let's start in gloomy old New York City, where the nation's largest telecom company, Verizon Communications Inc., VZ +0.13% just paid $130 billion to buy Vodafone Group VOD.LN -0.08% PLC's 45% stake in its Verizon Wireless joint venture.
That deal is interesting because it sets a clear value on the globe's most desirable, high-spending and high-margin communications customers. Verizon investors loved it.
So what would happen if we benchmarked revenueless WhatsApp against this gold standard of telecom deal-making? What would it take to give those WhatsApp customers some of the traits of the Verizon ones? In essence, how would we reverse-engineer a crazy deal into a noncrazy one?
At first, the numbers look as stark as you'd expect. We know that Facebook paid $42 for each of WhatsApp's 450 million users. Verizon, by comparison, valued each of its roughly 97 million monthly contract connections at about $2,984.

Verizon collected about $669 for each of these post-paid connections last year, and made another $168 per subscriber from other sources.
What did WhatsApp collect for its service, which allows for unlimited and quick text messaging? What a pesky question. Basically zero. For math's sake, let's take the figure to 50 cents per user in 2014.
This helps us get a slightly cleaner apples-to-apples comparison between the companies. That is what Wall Street calls a "multiple"—what each company is willing to pay for each dollar of revenue. By that measure, Verizon paid 3.5 times revenue per subscriber, and Facebook, hypothetically, 84 times. Still kind of crazy, right?
But that's just revenue. What about profit? Here's where things get interesting.
Befitting a behemoth, Verizon makes very good profits, with operating margins of 32% in 2013. This takes that multiple we just described to about 11. In other words: Verizon was willing to pay $11 today for each dollar of operating profit it collects today and into the future.
No one knows what WhatsApp's operating margins are. The indications are that the company turned a profit on its rumored $20 million in revenue. This we do know: It has about 50 employees—the staff of a decent-sized Verizon store. It has no marketing costs. No Washington lobbyists. No cell towers. No stores. No global campus. No sponsorship of the local symphony.
Arguably its single biggest expense is the 30% it pays Apple and Google to distribute its app. There are surely storage and bandwidth costs as its customer base grows. And keeping the software fresh requires some engineering talent.
But beyond that? We'll have to take a guess and peg WhatsApp's operating margins at roughly double Verizon, or 60%. New access to Facebook's servers and engineering talent should only improve that figure.
It is WhatsApp's dumb, elephantine hugeness where so much energy is concentrated. Let's take on Zuckerberg-ian ambitions and imagine WhatsApp can get to one billion users over the next few years. In fact, WhatsApp founder Jan Koum said Monday he wanted to develop services, including voice, for as many as two billion people world-wide.
Remember, we are trying to tweak our very hypothetical dials so each dollar of WhatsApp's operating profit is valued the same as a Verizon one, at roughly $11.
Doing this math, it would take $2.84 per year from every one of those one billion subscribers to get them equal to the Verizon valuation. That's less than a quarter per person, per month.
Sounds easy, but not feasible, either. Many WhatsApp users simply can't afford that. Others in Western countries have other means of communicating. There are a host of free competitors, too. Maybe only 10% of WhatsApp customers would pay that, perhaps more.
The Microsoft division containing Skype—an impressive communications platform of its own—reportedly brought in $2 billion in 2012 and at last count had 300 million subscribers. Can WhatsApp really bring in more than that?
For now, let's declare the whole WhatsApp undertaking: Crazy-ish.
And while Facebook might have done just this type of valuation exercise, it's clearly not the full reason why Mr. Zuckerberg bought the company.
He bought WhatsApp because it gives him a hook into hundreds of millions of customers, who may get shoved over to Facebook, and its ad platform, in ways even he's not dreamed of yet.
It's because he's paying mostly in Facebook stock, which is trading near its all-time high.
It's because he's keeping it out of the hands of Google and Microsoft.
It's because he doesn't have much to lose.
Maybe it's best to regard any WhatsApp revenue as partial insurance, a revenue stream that reduces the cost of these bigger strategic goals.
But it would be crazy in its own right to underestimate the power of hundreds of millions of people, much less a billion, each handing over a few high-margin dollars.
There's been so little precedent for business at this scale that we have a hard time simply comprehending all of this. I'm still learning, too.