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Forget the Punch Lines — This Tech Merger Means Huge Profits

15 | By Michael A. Robinson

My smartphone plays a vital role in my life.

And I’ll bet the same is true for you.

My two teenaged daughters are active in school, and have busy social lives. My wife is a successful professional. And with my own frenetic schedule – headlined by the work I do here for you – the text messages I send and receive using my Apple iPhone are often my only link to family and friends.

During the past week, for instance, I’ve texted my Mom in St. Augustine, Fla., friends in Denver, in Cabo San Lucas, Mexico, in Detroit and here in the Bay Area.

I use my phone as a data-storage device: It lets me access videos, movies … and my entire music collection.

And my iPhone has also established itself as an important work tool. I use it to track the stocks I’ve recommended, to follow the latest breaking news stories and watch the latest developments in such emerging trends as Cloud Computing, Big Data, the Internet of Everything and Miracle Materials.

The bottom line: My smartphone has become an integral piece of my everyday life.

Smart companies are looking for ways to capitalize on that fact – including one with a “killer app” that is threatening to stand the global telecommunications on its ear.

The company I’m talking about has been independently valued at $19 billion. But it’s been privately held, meaning there’s been no way to invest and capitalize.

That has all suddenly changed.

Thanks to a just-announced deal, this company has access to a whole new set of buyers, meaning it will be able to add to its 450,000-person subscriber ranks – in a big way. Combine all that growth with the belief that this company could radically alter the global telecom system and you have a recipe for big-time profits.

And today I’m going to show you how to cash in.

In fact, the stock I’m going to tell you about could double your money in as little as three years.

A Punchline With Dollar Signs

When Facebook Inc. (NasdaqGS: FB) recently announced it was buying the messaging service WhatsApp for $19 billion, it touched off an avalanche of controversy and criticism.

We saw comments from the usual market pundits and stock jockeys. But with WhatsApp – thanks to the unique name, and the immense purchase price – even the late night comedians stepped up.

This line from new “Late Night” host Seth Myers pretty much sums it all up:

“President Obama has announced that 4 million people have signed up for ObamaCare,” Myers deadpanned. “Obama says he wants to hit 7 million users by the end of March, at which point he’ll sell it to Facebook for $10 billion.”

The point of all these zingers was simple enough. To comedians – and the cable-channel stock jockeys – Facebook’s decision to spend $19 billion on a five-year-old startup with just 55 employees and 2013 revenue of around $20 million just seems, well, insane.

But as someone who’s been watching the tech sector, and who’s watched sector transitions like this one before, I’m going to make a prediction .

Two, in fact …

Facebook founder and CEO Mark Zuckerberg will have the last laugh here.

And if you follow my recommendation … so will you.

Let’s take a look to see why.

Killer Apps

Make no mistake: The WhatsApp deal offers enormous potential benefits for Facebook, which already derives something like 53% mobile ad sales.

And WhatsApp can become the straw that stirs the drink.

The startup has already become a key player the global mobile landscape. With WhatsApp pushing the boundaries of technology, apps are becoming high-tech cash machines.

To understand their value, look at two tech leaders – Apple Inc. (NasdaqGS: AAPL) and Google Inc. (NasdaqGS: GOOG).

In fiscal 2013, Apple had $10 billion in sales from its App Store. And Google, with its ubiquitous Android operating system, dominates the mobile market. Strategy Analytics said Android had a 79% market share last year. And after crunching the numbers, Forbes recently calculated that Google’s app store has enjoyed about 48 billion app downloads over the past several years.

The app market is huge. And apps play a critical role in the world’s high-tech ecosystem.

WhatsApp’s revenue stream model obviously doesn’t approach those of Apple or Google.

In fact, WhatsApp costs nothing for the first year of use and then is just $1 a year after that. But the potential of this platform for Facebook is simply stunning.

This acquisition could bring billions in new sales to Facebook in a very short period of time. If it just captured $1 a month per user in fees, ads and other services, Facebook would post around $5.4 billion in new sales on top of 2013 revenue of $7.8 billion – a 55% yearly increase.

No wonder Zuckerberg has been trying so hard to get into the messaging business. Just last year, he was spurned in a $3 billion bid to buy Snapchat, a messaging service popular with young users.

Running the Numbers

When you compare the price Zuckerberg paid for WhatsApp with the value of another popular mobile product, the acquisition really begins to make a lot more sense.

Twitter Inc. (NYSE: TWTR) is a micro-blogging service that has become a great source of breaking news. Just last Sunday, Twitter received enormous attention when Academy Awards host Ellen DeGeneres tweeted a photo of herself surrounded by several movie stars.

And yet, for all the attention Twitter gets, it still has a user base that’s still only half the size of the one controlled by WhatsApp. But at roughly $55 a share, Twitter has a market cap of $29 billion. In other words, the market says Twitter is 55% more valuable than WhatsApp – with only half the user base.

Fortunately, we have another recent major acquisition by which to model the Facebook-WhatsApp marriage.

Let’s take a look at the recent deal between Verizon Communications Inc. (NYSE: VZ) and Vodafone Group PLC (NasdaqGS ADR: VOD). The nation’s leading wireless carrier paid a whopping $130 billion to buy out Vodafone’s 45% interest in the Verizon wireless venture they owned together.

By that comparison, WhatsApp appears very cheap indeed. Verizon got roughly 97 million active monthly users, paying about $2,980 for each one. With WhatsApp, Facebook adds nearly half a billion new customers for about $42 dollar each.

And remember, Verizon has limited upsell beyond its monthly rates, data plans and roaming charges. But WhatsApp is a leading-edge firm in a new industry with unlimited potential.

In fact, WhatsApp founder Jan Koum plans to roll out a voice service in the next few months. He’s still leery of ads – despite their revenue potential – but Zuckerberg will almost certainly find a way to either host mobile ads or find corporate sponsors whose deep pockets can defray the cost of the user acquisition. And he will add new mobile services.

So there’s lots of upside on the revenue side.

On the flipside, WhatsApp doesn’t have a lot of expenses – it has only 55 employees. Tell me another business that could service more than 450 million dedicated users scattered over several continents with just 55 employees.

That’s actually the whole point of what makes mobile tech so profitable: You can “scale up” a business to a pretty hefty size – while maintaining a fairly small overhead.

This explains why Facebook’s stock is on a roll, rising 147% over the past year. The financials are great because the company is basically transitioning into a full-on mobile play.

The Next Phase

At the end of last year’s fourth quarter, Facebook had 1.2 billion active monthly users, up 16% from 2012. But active mobile users climbed 39% to 945 million, or 77% of its user base.

With a market cap of $172 billion, Facebook trades at roughly $67.50 a share. It has operating margins of 37% and an 11% return on assets (ROA). It has $11 billion in cash on hand and generated $2.85 billion in free cash flow (FCF) last year.

Over the past three years, Facebook has grown its earnings per share by 32%. At that rate, earnings and the stock itself could double in less than 2.5 years.

That would imply a price of about $140 a share before factoring in the lucrative potential of the WhatsApp deal.

Thus, Facebook ranks as a classic growth play. It’s a leader in the new field of social networking that has allied itself with the breakout firm in mobile messaging.

As I see it, tech investors have two choices with Facebook. They can give into the negative hype about this deal from the media and all those TV comedians.

Or they can take advantage of the huge upside and laugh all the way to the bank.

And laugh is what we’re going to do.

[Editor’s Note: What do you think about Facebook? We’d love to hear from you. Post your comments below.]

15 Responses to Forget the Punch Lines — This Tech Merger Means Huge Profits

  1. Richard says:

    I think you are right and I’m 70 years old.

    My next step is to analyze my acquisition and how large it should be.

    What happened to MEMS and that company that holds a production funnel?

  2. Richard says:

    I prefer to read the articles like this too audible pitches. Too long, too windy, too boring and out of the stream.

    Dragnet Detective Morgan “The facts, just the facts”.

    If your readers were stupid they would not be your subscribers so I’m looking for the separation from the HERD you promised.

  3. Maria says:

    Personally I have little time for face book/twitter. Occasionally I respond to friends or family but most off them are prolific users and serial profile changers lol

  4. Jeffrey Herman says:

    I believe FB is the social media giant of the next decade however I was listening to a message from Keith Fitz-Gerald last night who stated that he felt social media stocks were not going to be very lucrative. In fact he stated that they would decline however he didn’t mention any by name. Was he excluding FB?.

  5. Larry Vowell says:

    Thanks for sorting this out and making sense of the numbers. Before this I thought it was a lousy buy. Do you think getting in immediately would be a good move?

  6. Steve Zimmerman says:

    Social media is growing like crazy, but users are becoming less sociable each and every day. I will look for investment opportunities elsewhere and at the same time disdain any use of Facebook Twitter, Linked-in or what have you. Only hindsight will prove whether this is just another bubble not yet popped, but in more than 45 years of serious investing, it certainly feels like one. So, I will abstain from joining into this craze and just wish those that do will not later rue the day that they ‘bought in’.

  7. James McCoy says:

    I find Facebook to be so full of static (inconsequential blather) that I rarely look at it. However, my kids use it as a matter of course. Whether I like it or not has little bearing on whether it can make me some cash. So, I think Ill buy a few shares.

  8. Neil Buskell says:

    I am unclear on the numbers – you show

    Thanks to a just-announced deal, this company has access to a whole new set of buyers, meaning it will be able to add to its 450,000-person subscriber ranks

    but later say

    Tell me another business that could service more than 450 million dedicated users scattered over several continents with just 55 employees.

    So which is it – 450k or 450m?

    Is it the subscribers that bring in the money or the users?

  9. Helene says:

    I am not a techie, have no I-phone or I-pad, just a computer. Am not on Facebook or any other social site.Guess, I am one of the few who doesn’t need all the newest info.

  10. Alex f says:

    Very interesting Mike but I have to ask the question – wouldn’t the majority of the whatsapp users also be current Facebook users too??

  11. Mona Ledoux says:

    I’ve found old school friends on Facebook and connect with family, too, but what has also been happening is that ads are catching my attention. I’ve discovered new products and have purchased them. So, I can see where Facebook has tapped a new market.

  12. Donald W. Sperry says:

    What a pity social media isn’t able to teach calculus, or how to construct a sentence. It would merit the current stock price of $140/share, if it were. Alas, because it can’t, it has a value approaching zero when compared to the value of someone who can do either, or both, of those things The attractiveness of the inane will forever mystify many of us who place more value on learning about that which elevates a society. Without taxing the imagination overly, I would be interested in finding out what it is about Facebook which either elevates a society, is productive, or has lasting value.

  13. Merv says:

    I hate Face book. I would never use it or get involved with it. It will become (if it isn’t already) an arm of the world wide spy network and record every tiny thing about its users (you) it can get, and pass it on unrestricted to any government or organisation it is ordered to so do. I believe it is the most ridiculous time wasting thing ever to blight the electronic universe and people’s lives. Because of that, and because of people’s intoxication with it, I also believe it has only started on its meteoric rise in share price. I remember a few years ago, I laughed when Google was the same price as Face Book is today. I never bought in. Dot comms were blowing up everywhere. I believe Facebook’s share price will be over $1,000 within 3 years if not sooner.

  14. Leo Saidnawey says:

    How did we survive before all this technology. At 86 I use the computer 3 to 4 hours a day for business and pleasure.

    With my phone whatever information I need is but a few minutes away.

    Thank you for this technowlegy

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