WhatsApp Price Ups the Ante in a Big-Spending Industry

The $19 billion that Facebook Inc. is paying for a smartphone application, one of the biggest tech deals of all time, made jaws drop even in Silicon Valley, where entrepreneurs tend to have an inflated sense of their own worth.

“It’s 19 Instagrams,” observed serial startup entrepreneur Adam Rifkin, referring to the $1 billion Facebook paid for the popular photo-sharing app in 2012.

But analysts say the purchase of WhatsApp could pay off for Facebook as it takes on Google Inc. and other technology giants in the escalating arms race to be the next big thing in mobile.

Technology giants are fighting for their future as consumers switch their allegiances from personal computers to mobile devices.

As a result, nimble startups that have outpaced their grown-up rivals in building popular mobile services have become takeover targets, commanding stratospheric valuations.

Just last year, Facebook offered $3 billion for Los Angeles-based messaging company Snapchat, but was rebuffed. WhatsApp, a tiny Mountain View, Calif., company with a startling growth rate and rising popularity around the globe that Facebook had pursued for years, was a far bigger prize.

With 450 million users, WhatsApp is the market leader in mobile messaging.

The stakes could not be higher for Facebook. More and more people are communicating one on one or in small groups on their mobile devices, rather than blasting information to hundreds of friends on social networks. Its very survival depends on its ability to latch onto the new ways people are connecting and sharing.

By that logic, the price Facebook is paying for WhatsApp isn’t so bubbly, said David Wessels, a finance professor at the University of Pennsylvania’s Wharton School.

“As a stand-alone company, WhatsApp is clearly not worth $19 billion, period,” Wessels said. “But by no means would I consider this irrational. Would you give away 10 percent of your company to extend the life of your company?”

Another benefit of the deal: Facebook kept WhatsApp out of a competitor’s clutches.

Google reportedly offered $10 billion for WhatsApp. And last week, Google CEO Larry Page personally met with WhatsApp chief executive Jan Koum in a last-ditch effort to talk him out of selling his company to Facebook, according to the technology news service The Information.

At first, Facebook investors did experience what Sterne Agee analyst Arvind Bhatia called “sticker shock” after learning that Facebook planned to shell out $19 billion in cash and stock for WhatsApp, a company that had declared it had no plans to make money any time soon.

The deal values WhatsApp higher than 275 companies in the S&P 500 index – a remarkable shift in fortune for the company founded in 2009 by former Yahoo employees Brian Acton and Koum, a Ukrainian who came to the U.S. when he was 16 and lived on food stamps.

But investors quickly shrugged off concerns. Shares of Facebook briefly hit a record high of $70.11 Thursday, the day after the sale was announced, before closing up 2 percent to $69.63.

Even though the extraordinary sum Facebook is paying for WhatsApp defies any traditional means of evaluating the worth of a company, Facebook is certainly not alone in placing skyscraping valuations on unproven startups, analysts say.

Blogging service Tumblr sold to Yahoo Inc. for more than $1 billion. Google spent nearly $1 billion on social mapping company Waze. Dozens more startups in Silicon Valley are valued at $1 billion or more. And in January, startup valuations hit a new high when Dropbox closed a $250 million round of funding that valued the online-storage company at nearly $10 billion.

It isn’t 1999, but companies with loads of users – but few prospects for making money – are being handed lofty market values, said Aswath Damodaran, who teaches corporate finance and valuations at New York University’s Stern School of Business.

According to research firm Statista, Facebook is paying $42 for each WhatsApp user, which is roughly what it paid for an Instagram user. That compares to Facebook users, who are valued at $141.32 apiece based on the company’s market valuation, and Twitter users, who are valued at $83.53 apiece.

Facebook is quick to point out that WhatsApp reached 450 million users faster than any other company in history, doubling its user ranks in the last year. By way of comparison, Facebook had fewer than 150 million users after its fourth year, a third as many as WhatsApp in the same period.

Then there’s the matter of WhatsApp’s strong aversion to the ways consumer internet companies typically make money, namely through advertising. This week, Koum reiterated that his company would never sell ads, and Facebook co-founder and chief executive Mark Zuckerberg backed him up.

Damodaran said it’s anyone’s guess whether WhatsApp will ever justify its eye-popping valuation.

“If you look back at the dot-com era, the companies were collectively overvalued. But there were winners,” he said. “The winners here won’t be those with the most users. They will be those companies that are successful at converting those users into revenues.”