Investors ignored Game-Changing Deal; WhatsApp


In January 2009, Jan Koum bought a new smartphone.

A top-of-the-range iPhone 3G.

As soon as Jan booted up his new device, something exciting dawned on the young infrastructure engineer.

He realised that the Apple App Store – then just seven months old – was about to spawn a whole new software industry.

That gave Jan an idea…

Jan worked on the idea day and night for the next several months until he’d perfected it.

Jan’s idea would eventually make him an incredibly rich man. But when he released his idea to the world, investors wouldn’t even give him the time of day.

If you’d been browsing the online forum ASmallWorld on the 4th of May 2009, you might have come across this post…

Source: The Reformed Broker
Click to enlarge

We’re told the post above received no replies. Zero.

Five years and $19 billion later…

Unless you’ve been under a rock for the past week, you’ll have seen that Facebook Inc [NASDAQ:FB] has just agreed to buy WhatsApp, a four-year old text messaging company with 55 employees and $20 million in annual revenue, for $19 billion.

At face value, that’s a staggeringly large sum of money.

And yes, this deal dwarfs most high-profile tech acquisitions. It’s more than the combined total Microsoft [NASDAQ:MSFT] shelled out for Nokia’s mobile phone business and for Skype…and it’s much more than Google [NASDAQ: GOOG] paid for YouTube.

But large doesn’t necessarily mean expensive. And it’s important to realise what Facebook has really bought here. There’s an important lesson in it for investors…

Price is What You Pay – Value is What You Get

Facebook has just bought a company that processes 50 billion free messages a day. WhatsApp has grown to more than 450 million users, and 70% of those users log into the app every day. That level of engagement is valuable because the more users interact with a service, the more ads or other products can be sold to them.

Brian Blau, an analyst at research and advisory firm Gartner Inc [NYSE:IT], put it best when he said:

If you’re a technology player today, and you’re in the communications business, then you need a way to capture people and bring them into your ecosystem. Virtually anybody in the technology space that has a pillar product around conversations and connecting people together could be a potential buyer.

Facebook paid $42 per WhatsApp user…a great proportion of them are highly active. In fact, the average WhatsApp user sends more than 1,000 messages every month!

But compare $42 per user to the price commanded by the other major social networks. $42 is a fairly cheap price for a pair of eyeballs…as you can see in the chart below, which compares WhatsApp to its social network peers.

Source: Statista
Click to enlarge

You’ll note certain words missing from that chart: ‘sales’, ‘cashflow’, and – god forbid – ‘earnings’.

And that’s fine.

Mark and friends will figure out a way to monetise those users. In the long run, it’s not hard to see WhatsApp getting anywhere from $1 to $10 per user annually. That would make it a lucrative business in its own right.

And that’s before you consider the less tangible benefits that come from extending Facebook’s reach.

According to mobile research firm Jana, 55% of people surveyed in India said WhatsApp was their most-used messaging service. That response rose to 63% in Brazil and 78% in Mexico.

Those kind of penetration rates – and the swathes of personal data that come with them – will be a godsend to Facebook as it pushes into emerging markets.

But WhatsApp isn’t the only communication software start-up that’s been snaffled this month for big dollars…

Lost In The Noise

If it’s possible for an international takeover worth close to a billion US dollars to get drowned out in market noise, well, that’s what happened two weeks ago.

That’s when Japanese e-commerce giant Rakuten Inc [TYO:4755] announced its purchase of voice-call app-maker Viber for $900 million.

On any valuation metric, the price that Viber’s owners achieved for their business looks pretty shabby compared to WhatsApp’s $19 billion price tag.

Should Viber’s founder, Israeli entrepreneur Talmon Marco, feel hard-done-by to have only gotten $900 million for his app?

I’d imagine Talmon has spent a few sleepless nights this week wondering what might have been if the WhatsApp deal had been announced before he’d agreed to sell. It’s clear that tech industry heavyweights are now placing a much higher price on strategically important assets.

You may not have noticed, but stories like the WhatsApp acquisition are constantly playing out in the Australian stock market.

The only difference is that you don’t have to be a secretive fund manager like Sequoia Capital to win this game. That’s the venture capital firm that backed WhatsApp five years ago in exchange for a share in the business. As Kris Sayce told you last week…with the Facebook takeover, Sequoia made a 35,525% return on their initial stake in WhatsApp.

While that sort of gain doesn’t happen often, opportunities for big triple-digit or quadruple-digit percentage gains do happen relatively often. All you need is the courage to take on some calculated risks in exchange for the potential to make huge gains.

I’m talking about investing in the opportunities we find amongst the speculative small-cap companies listed on the ASX.

Not just smaller Aussie companies with revenue, profit and an established business plan…but tiny firms with little more than some start-up capital and a bright idea.

The potential to make huge gains

These small-cap companies typically ask you to invest in their business before they have an idea of how they’re going to make any money.

Many of these companies will fail to reach their full potential. But some will…and if you get along for the ride, the returns will be breathtaking.

Here’s a tip on how to find the next Aussie WhatsApp…an investment that’ll go on to pay you as much as 35,525% more than your initial outlay.

Look for a small company with three things: a unique asset, barriers to entry and smart operators at the helm.

If you find a company that ticks those boxes at the right time, the rest will look after itself.

You don’t get $19 billion small-cap takeovers every day, but the huge deals we’ve seen in the past two weeks show you what can be possible.

The trick is in finding these companies before everybody else does. That’s not always easy.

My recent research has unveiled tiny Aussie companies building unique businesses in high technology, alternative finance and online retail.

Will these be the next Aussie WhatsApp? Maybe. Maybe not.

But either way, these are exciting stocks with a great future. They may not return investors a 35,525% gain…but if my analysis is right, high triple-digit percentage gains are a realistic possibility.

It’s an exciting time to be an investor, especially a small-cap investor.

Tim Dohrmann+
Analyst, Australian Small-Cap Investigator

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