Facebook’s horrible, stroke-of-genius IPO

By Felix Salmon
February 20, 2014

Two years ago, before Facebook went public, I wrote a feature for Wired with the title “For High Tech Companies, Going Public Sucks”. It was illustrated with this Mark Zuckerberg sadface:

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As it happened, going public did suck for Mark Zuckerberg — much more than even I thought that it would. But, like many things which look really horrible at the time, it turns out to have been the best thing that Zuckerberg could have done. Facebook, today, has a real chance of sticking around and dominating the world for many years to come — and it only has that chance because it went public when it did.

The reason is simple enough to be summed up in one word: mobile.

At the time of the Facebook IPO, 21 months ago, the markets knew full well what the biggest challenge facing Facebook was. The desktop product was wildly popular, but the mobile product wasn’t, and it was far from clear how Facebook could thrive in a world based around the smartphone. Zuckerberg had one job above all others: manage the transition to mobile, and do it as fast and as aggressively as possible.

And that’s exactly what he did.

By the time last quarter’s earnings came out, Facebook was getting 53% of its revenue from its 945,000,000 mobile users: nobody saw that coming at the time of the IPO. Facebook has monetized mobile better than any other website in the world, and its in-stream native ad units are impressively powerful. Brands aren’t buying them because they feel the need to be cool, they’re buying them because they work.

Zuckerberg, however, wasn’t satisfied with purely financial metrics. Mobile is a completely different world, and the move from desktop to mobile, for Facebook, had to be — and had to be seen to be, both internally and externally — as the central, company-defining strategy of the 2010s.

The technology world moves fast, and companies need to be able to change or die. If you change, then you can thrive: look at Netflix, for instance, a far cry from its DVDs-by-mail roots, or look at IBM, which has managed to pivot from making PCs to, um, whatever it is that it does now. (I’m a bit unclear on what that is, but the numbers speak for themselves: it made $16.5 billion of profits in the last 12 months, on revenues of $100 billion, and has an enterprise value of $220 billion; its share price is higher than it was even at the height of the dot-com bubble.) Look, most canonically, at Apple, which transitioned with spectacular success from making computers to making phones.

Or, alternatively, look at Microsoft.

Zuckerberg knew, circa Facebook’s IPO, that his company was not good at mobile: it didn’t have the problem solved. And he knew that asking his existing corps of engineers to turn their attention to mobile would probably not work. But the good news was that he was now running a public company, with lots of cash, and a highly-valued acquisition currency in the form of Facebook stock.

The world of mobile is in large part a lottery. The most successful products aren’t the best-made; they’re just the ones which managed to catch on, for whatever reason, and generate positive word of mouth. The perfect example: Flappy Bird, a game written in a single day, released with no fanfare onto the iOS app store, which went absolutely nowhere for over a year, before suddenly exploding in global popularity for basically no reason.

Facebook bought Instagram for $1 billion in 2012 not because the product was particularly great, but because the product was insanely popular. The same when he offered $3 billion for Snapchat. Sometimes, lightning strikes. And while Facebook is happy writing its own mobile apps in the hope that lightning will strike them, it knows better than to count on such a thing happening. If you want to be certain that hundreds of millions of people are using your mobile products, the only way to do that is to buy mobile products which hundreds of millions of people are using.

Facebook’s acquisition of WhatsApp sums up Zuckerberg’s strategy perfectly. WhatsApp is an ugly, clunky product with a juvenile name; there are dozens of prettier, smoother, more elegant mobile messaging apps out there. But, even more than Instagram, it’s also insanely popular: think of it as the Drudge Report of messaging apps. Facebook itself has never put much stock in elegance: its own site has always been pretty cluttered, mainly because it turns out that cluttered and ugly often works really well. (Look at any Chinese portal.) There is nothing intrinsic to the WhatsApp product which Facebook hasn’t already developed on its own. But WhatsApp has hundreds of millions of incredibly loyal users, all over the world, and that’s all that matters.

The price, of course, is high. But most of it is being paid in Facebook stock, with the cash component coming easily out of Facebook’s massive cash pile. Issuing Facebook stock, especially if doing so buys you the future, in terms of a young global user base, costs Zuckerberg effectively nothing: the share price is basically flat today, while it would surely have fallen much further had, say, Microsoft bought WhatsApp instead.

But that’s the difference between Facebook and Microsoft. Zuckerberg is the same generation as the people building today’s most popular mobile apps: he speaks their language, and he lives in the Bay Area, where they live, and — most importantly — he has complete control of his company, so if he decides that he wants to drop $19 billion on company with 55 employees, he can go ahead and do just that in a matter of days. At Microsoft, such a deal would probably be brought to some M&A person by a banker, and Microsoft would spend months kicking the tires, and there would be endless meetings about whether to do the deal and how much to pay, and the target company would get so frustrated over the course of the process that it would probably end up saying no regardless of what the eventual offer price was.

The WhatsApp acquisition is a statement by Zuckerberg that mobile matters more than money. He’s right about that. Without mobile, it doesn’t matter how much money Facebook has. If you’re asking whether Zuckerberg paid too much for WhatsApp, you’re asking the wrong question. Zuckerberg is sending a message, here, that Facebook will never stop in its attempt to dominate mobile — that no amount of money is too much. Zuckerberg has money — and, thanks to the IPO, he can even print money, if he wants, by issuing new Facebook stock. He’s playing large-stack poker, and he’s playing it in textbook manner. I, for one, wouldn’t want to be competing against him.

11 comments

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So the newly-issued stock doesn’t drive down all the relevant financial ratios, causing rational investors to question the valuation, leading to possibly sharp declines in FB stock? “Can print money,” sure. But if it’s that easy, why not a $100 billion valuation for a 55 person company? Yahoo pursued a similar kind of strategy for a few years in the dot com heyday. 14 years later, YHOO is valued at $37.5 billion… only double that WhatsApp company and 22% of FB’s current valuation. Pathetic! “Printing money” not only devalues the money eventually, but it’s also not a proven way to take over the world. Maybe those “bankers and M&A specialists know something Zuck doesn’t.

Posted by PZMedia | Report as abusive

Firstly, Flappy Bird’s entire existence has been less than one year. And it was developed in two to three days, not one. Let’s get our flappy facts right.

Secondly, “Issuing Facebook stock … costs Zuckerberg effectively nothing: the share price is basically flat today, while it would surely have fallen much further had, say, Microsoft bought WhatsApp instead.” This is really confused. Specifically, you’re confusing finance with product strategy. Facebook could have in principle decomposed this move into an all-cash deal, followed by an unrelated dilutive share issuance into the markets.

Their stock is pretty liquid at this time and scale, but WhatsApp still would have slightly preferred that deal, hence Facebook was the one that wanted to use stock. All that’s going on here with the stock component is that it’s a backdoor capital raise, since doing it as above would have drawn attention/ire. (It might have been annoying to execute as well, and now they’ve shifted that burden onto the WhatsApp owners.) This has zero to do with this specific deal and more to do with Facebook’s general desired financial posture.

Also, you should know better than to read tea leaves in that stock move – some of it’s from the product strategy implications, some of it’s from the effect of the dilution, and there’s no connection between that dilution and some weird counterfactual where Microsoft bought WhatsApp instead.

Posted by absinthe | Report as abusive

Sure Felix… selling ownership in an asset without giving up any control of that asset generally is a good idea. Literally having your cake and eating it too.

I will now demonstrate the lunacy of paying 19 billion for a free app service. Facebook could have done it’s own version of Snapchat AND PAID A BILLION PEOPLE $5 TO USE IT. A fool and his money are easily parted… so too a genius and his infinite supply of non-voting stock! Zuck should sell 10 billion more shares and buy AAPL… Tim Cook could then keep on running it and tell Carl to go pound sand! It’s 1999 all over again baby!

Posted by y2kurtus | Report as abusive

I think you’re right, Felix. $4B in cash & ~$15B in overvalued $FB stock gets them better connected in mobile. Now Zuckerberg has to make sure that however they integrate or monetize WhatsApp, it doesn’t destroy the underlying value of either part of the business, and drive users away.

Posted by DavidMerkel | Report as abusive

These acquisitions also have to be viewed as defensive moves. Any network effect-based app doing really well is a real threat to FB, so it’s worth any amount of money to keep them from becoming the new, cool social network (especially when Google has already tried to buy them).

Posted by AngryInCali | Report as abusive

Isn’t there a corollary to your mobile story? If apps can take off for no known reason, then couldn’t they also be abandoned when interest shifts to a new app for no known reason?

It seems like Facebook is buying what they can’t build themselves. Not a horrible strategy, but also not particularly “genius” as you seem to believe.

Posted by Harpstein | Report as abusive

When you say it doesn’t matter how much they pay or how many shares are outstanding, you’re saying it’s a bubble. So don’t pretend to care about anything else.

Posted by rvm3 | Report as abusive

What Harpstein said… We have plenty of evidence proving that apps can grow rapidly, much faster than the total usage expands. Most of the growth at this point cannibalizes other apps.

In such an environment, a mature app has to be viewed as a depreciating asset. Something new will come down the pike in a few years, pushing those that came before it to the side.

Posted by TFF | Report as abusive

@y2kurtus like many others just do not understand WhatsApp’s business model. It’s not free, it’s only free for the first year, enough to get you addicted.

After that, it’s $1/year, low enough that pretty much all their users pay for it. That’s right, a company with 55 people makes >$400m/year…. There is no need to ‘monetize’ WhatsApp, it’s doing that just fine on it’s own. Quite frankly is a genius business model.

If you look at highly valued tech company P/E ratios, then look at WhatsApps current revenues, then the price is not that out of line.

So, for effectively $4b in cash outlay + some stock, you buy a company at 20-25x earnings which is growing like mad, is cash-flow positive, has a strong & viable revenue model and has a hugely desirable user base.

Seems like a very, very smart deal to me. I think that the stupid people are the ones who do not see just how smart this deal actually is….

Posted by ckm5 | Report as abusive

@ckm5, it sounds like you are assigning a value of $0 to the stock portion of the deal. If that is realistic, then Facebook is grossly overvalued.

Posted by TFF17 | Report as abusive

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