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My head is still ringing from the news that Facebook (NASDAQ:FB) agreed to purchase mobile messaging application WhatsApp for $19 billion yesterday - a deal worth $4 billion in cash, $12 billion in Facebook shares, and an additional $3 billion in restricted stock. My first reaction was eye-opening awe at how large the number was. I remember marveling when FB bought Instagram, a mobile photography app, for $1 billion in 2012. A team of a few engineers and product developers selling a revenue-nil application for a ten-digit sum. But as I started to dig into the $19 billion newsflash today, the picture started to look a lot clearer. This could go down as the most effective move FB has made so far.

Why FB Needs WhatsApp

FB is not an innovative company. They haven't been for a long time. Mark Zuckerberg leads a company of incredible executors, but the idea behind FB has never been cutting-edge. They came about in a time when MySpace and Friendster were doing pretty much the same thing; FB just did it all better. It's important, then, that the company be open and willing to vertical innovation through acquisitions, which it first proved with Instagram and showed again today in a big way.

We've all heard the stats by now: WhatsApp currently has 450 million monthly active users, 72% of which (or 324 million) are active on a daily basis. The platform is currently ad-free, and Zuckerberg has stated that it will remain that way. Monetization (and justification for such an astonishing purchase price), then, will come from the current annual fee that WhatsApp users pay - $1.

The FB Financial Picture & WhatsApp

FB currently boasts 1.28 billion monthly active users, which yielded $7.87 billion in revenue for FY 2013. Investors are optimistic about the stock company as of late, which has driven shares higher during the past year to their current trading levels of $68 prior to news of the acquisition. At that level, the Price-to-Sales ratio for FB was 22x.

How, then, does WhatsApp fit into that mix? If FB believes they can continue to develop new users with WhatsApp - which is currently adding 1 million new users per day at an accelerating rate - then the $19 billion ticket price starts to become a lot more reasonable. With their reach, if FB could grow the current 450 million user base of WhatsApp to 1 billion in the next year - which the application was nearly on pace to already accomplish - then the new parent company will have added $1 billion in incremental new revenue to their top line with the current pricing structure. At a Price-to-Sales ratio of 22x, that equates to market cap expansion of $22 billion over the first year. The 22x is not something to be scoffed at - this is the level that investors currently believe FB should be operating. For every dollar of revenue they generate, the stock should be worth $22. Why, then, does acquiring a company that could quickly trade at 19x seem out of this world?

How Will FB Optimize?

If you use Instagram, you've noticed subtle but substantial changes during the past year. The monetization process has begun when ads showed up. Admittedly, the ads were engaging and effective - FB carried on the success they had with their own sponsored newsfeed ads and created a seamless integration of advertising spots into the user's current Instagram feed. In addition to the monetization changes, Instagram became much more linked to the FB platform - tagging users in Instagram photos automatically showed up on their FB pages, direct messaging of photos became an option, and Instagram action/engagement on the FB platform became more commonplace in the feed.

As noted, Zuckerberg will not add advertisements to WhatsApp. Monetization will continue under the current $1 annual fee plan, but there's also tremendous room for growth. The New York Times ran an article detailing the emerging data communications apps (WeChat, KaKaoTalk, Line) that are being used primarily in Asia. WeChat is the biggest name there, and the chief competitor of WhatsApp. All are capitalizing on sticker sales, which made up 30% of Line's annual revenue in 2013. KaKaoTalk generated $311 million in revenue with in-app game sales.

The troubling notion for FB is that most of the revenue made off sticker sales is in Asia and WhatsApp has a very low penetration in the Asian market. While WhatsApp dominates share in North and South America, Africa, Europe and Australia, the Asian market is left largely untapped. It's up to the FB team - with broad reach and ever-expanding user base - to attract Asian users to WhatsApp.

(click to enlarge)

In addition to sticker sales and other incremental sources of in-app revenue, investors should consider the larger picture that the world is moving toward an environment of broadband communication rather than cellular communication. According to London consulting firm Ovum, mobile SMS plans accounted for $120 billion in annual revenue in 2013, but wireless providers are losing market share to broadband messaging apps at an alarming rate. These apps took $25 billion, or 17% of the market from wireless carriers in 2013 and that number is only increasing. The value of the WhatsApp deal then not only becomes the current revenue streams that are in place through user fees, sticker and other in-app game sales, but the offsetting of the $120 billion SMS industry which is happening as we speak.

Conclusion

I'm not recommending you buy shares of FB. You'll buy if you believe the stock trading at 22x Price-to-Sales is a fair valuation. I'm pointing out that despite all of the negative sentiment around this acquisition, FB might have just made its best move yet. The purchase is roughly a 10.5% dilution that could quickly contribute its equal weight in revenue - and then substantially more - to the growing social media giant. Additionally, the acquisition provides for a vertical integration into a currently under-tapped market for FB. Mobile messaging and the WhatsApp acquisition have the potential to do three very important things for FB - increase the company's overall mobile portfolio, raise the revenue-generating power of the individual user and contribute to top-line growth on the P&L, and help the company continue its mission of making the world a more connected place. Investors have doubted the company before and, in the wake of a $19 billion purchase and 10% dilution, they'll surely doubt again. FB has proven the push towards mobile is generating profits at an accelerating rate, they've showed substantial revenue growth since their IPO, and they continue to cement themselves as the largest connector of people the world has ever seen.

$19 billion is a lot of money. The potential return is worth it.

Source: Why This $19bn Is Facebook's Best Move Yet