Bone-headed valuations marking the end of the cycle

The big headline is the deal Facebook made to acquire WhatsApp for an absurdly large piece of change – $4 billion cash and $12 billion in stock. There was also $3 billion in extra restricted stock that vests over four years, but really, $3 billion is a rounding error.

The owners of WhatsApp should be given a massively huge congratulations for extracting a huge pound of flesh and hopefully they will have the foresight to start hedging their stock so they’ll be able to live in luxury forever.

I highly suspect in five years or so that the guys at Snapchat and Instagram are going to be kicking themselves for not dumping their businesses at equally absurd valuations. They’ll probably end up being like Friendster when they are superseded by some other up-and-coming application service.

I am not a user of either technology, either Facebook or WhatsApp (or Snapchat and Instagram for that matter!). Today was the first time I ever heard of WhatsApp, and just looking at the Wikipedia summary, it looks like a well-used and functional version of BBM crossed with Skype.

This also explains why Blackberry is up today – if WhatsApp can fetch $16 billion, why can’t BBM?

Media is already panning the deal and I seriously have no idea whether this makes any sense for Facebook strategically – eventually they will want to fold the WhatsApp’s not insubstantial user base into Facebook in some seamless transition, but one can just ask Google how things went with Google+ and you’ll easily see it is a lot easier to do that on paper than it is in practice.

Financially, of course $16 billion is a huge price to pay. Even if you assume the stock component of the deal is worth zero, the $4 billion in cash is a huge investment. Putting that $16 billion in a 30-year treasury bond will reliably spin off $600 million a year in pre-tax income for 30 years and does anybody seriously think that WhatsApp will contribute that incremental income to Facebook’s bottom line?

This acquisition reminds me of what happened when Yahoo acquired (from Mark Cuban), or the mergers that occurred in the optical networking space in the last couple years of the dot-com boom where you had massive equity-for-equity transactions (in particular, JDS, Uniphase, and SDLI come to mind).

Acquisitions like these highly suggest the 20-times-sales valuation hype is going to end sooner than later. I don’t know when, but I’m staying far, far away from this territory and letting the insiders and lucky day trader-types make their killing to the detriment of those that will be holding the bag when the party ends.