What’s Up? – WhatsAPP?

illustration of piano falling on man with umbrella

There is so much going on that a very big event, Facebook’s acquisition of WhatsApp, might get obscured by other news.

Russia invaded the Crimean peninsula of Ukraine. Being a noteworthy topic, there should be plenty of punditry to inform all of us on the significance of this event. Here's what I believe:

  • Ukraine has a GDP of about 175 billion dollars just behind Kazakhstan. That's about 1% of our GDP.[i]
  • Putin wants to reacquire more former Soviet Bloc territory and create a bigger buffer between Russia and Europe.
  • Europe wants more buffer between itself and Russia.
  • Ukraine is a geographically critical country for both Russia and Europe.

Beyond this fact, I think something more telling for our economy occurred this week.

Noteworthy investor Warren Buffett issued his annual letter, which is widely anticipated each year. Buried in the 24-page document there are a few nuggets of gold for any investor.[ii]

  • “You don’t need to be an expert in order to achieve satisfactory investment returns.” However, Buffett noted that non-experts must know their limitations and follow a plan certain to work reasonably well. Keep it simple and “don’t swing for the fences.”
  • “Focus on the future productivity of the asset you are considering.” If you aren’t comfortable estimating its future earnings, move on; you need to understand the actions you are taking. If you are focusing on potential price change, you are speculating. “Games are won by players who focus on the field – not by those whose eyes are glued to the scoreboard.”
  • Buffett advocated for non-professional investors to own a portfolio of businesses that together are bound to do well versus picking “winners”. Index ETFs are a vehicle to achieve this.[iv]
  • He also cautioned against acting irrationally due to the irrational behavior of other investors.

Certainly when a successful long-term CEO/investor and the 4th richest man in the world speaks, people tend to listen.[iii]

Neither Ukraine nor Buffett are as telling an event as Facebook paying 19 billion dollars for a virtually unknown company, WhatsApp.[iv] Some might discount this as a simple act of overpaying for an instant messaging company. That's certainly a reasonable judgment.

After all, WhatsApp was started in 2009 with as little as $250,000 in seed funding. A few years later, they took a cash injection of 8 million dollars. They have about 400 million active users sending 10 billion messages and 400 million photos a day. That's about $48 per user that Facebook was willing to pay.[v]

The fact that Facebook would pay this amount for a company with about 55 employees is indeed astonishing, but for me, it's not really about the valuation.[vi] When Facebook is willing to pay the same value as The Gap, Whole Foods Market, Waste Management, and Sherwin Williams, it's time to look at the world a little differently.

Troubling, this buyout continues to reinforce my belief that the labor market has tact away from significant job creation. WhatsApp has a sum total of 55 employees. Shareholder value has nothing to do with large employers. Take a look at the list below:

Company

Market Cap

#Employees

Valuation per Employee

WhatsApp

$19.0B

55

$ 345,454,545

Sherwin Williams

$19.9B

37,633

$ 528,525

Waste Management

$19.2B

43,500

$ 440,690

Whole Foods Market

$19.8B

80,000

$ 247,500

The Gap

$19.2B

132,000

$ 145,758

Sources: Market Caps from Google Finance. Employee counts from Wikipedia corporate profiles and Whole Foods Market web site.

Mostly though, this buyout tells me something about the nature of what's going on in Corporate America. Non-financial companies are sitting on 1.63 trillion dollars in cash and cash equivalents, and it may no longer make any sense to invest heavily in R&D.[vii] After all, WhatsApp invested a pittance compared to most large R&D budgets and walked away with a value based upon their ability to dominate a market space. Mohamed El Erian, the former Co-CEO of PIMCO, calls this a "winner-take-all" economy.[viii] Less convinced that “normal” innovation yields big payoffs, companies invest less in R&D.

If you look at companies like Apple, Google, Microsoft, and Hewlett Packard, one can question the old approach of linking R&D expenditures to improved values. Perhaps this is one of the reasons why companies are sitting on their cash.

Company

R&D Expenses

Cash and Equivalents

Hewlett-Packard

$3.14B

$21.72B

Microsoft

$10.41B

$87.87B

Apple

$4.48B

$146.76B

Google

$7.95B

$60.69B

Source: Yahoo Finance, latest fiscal year income statement and balance sheet.

I believe WhatsApp tells us something about the changing nature of not just employment, but perhaps corporate capital deployment. If it only takes a minuscule investment to build shareholder value, why deploy the 1.63 trillion dollars in corporate cash balances?

WhatsApp is much more than what's up. It might just be what's coming.

If you have questions or comments, please let us know as we always appreciate your feedback. You can get in touch with us via Twitter, Facebook, or you can email me directly. For additional information on this, please visit our website.

Tim Phillips, CEO – Phillips & Company
Jeff Paul, Senior Investment Analyst – Phillips & Company

[i] 2012 Ukraine GDP. http://www.tradingeconomics.com.

[ii] 2013 Shareholder Letter. Berkshire Hathaway. http://www.berkshirehathaway.com/letters/2013ltr.pdf. p 18-20.

[iii] Forbes (2014). The World’s Billionaires.

[iv] O’Brien, Chris. (Mar 3, 2014). Confirmed: Facebook’s $19-billion WhatsApp deal is Jaw-Dropping. The LA Times.

[v] WhatsApp. Wikipedia.org.

[vi] Ibid.

[vii] Federal Reserve Economic Data. Sum of Non-financial Corporate Business: Checkable Deposits, Time and Savings Deposits, Money Market Funds, Treasury securities, and Commercial Paper, using the latest data available for each category.

[viii] Weisenthal, Joe. (Mar 2, 2014). Mohamed El-Erian Has a Fascinating Theory for Why Companies Aren’t Spending More Money. Business Insider.