Why did Facebook pay so much for this communication app?

Facebook and WhatsApp have completed a $16 billion deal plus an extra $3 billion that came through after the deal’s completion. The mobile messaging company has 450 million users and only 55 employees; however, it does not garner a lot of revenue nor is it clear what the profit margins are. Additionally, they run no advertisements. The company was long considered a takeover target because of use by teens and rapid growth.

The Fed released minutes from their January meeting. As the unemployment rate nears 6.5%, a minority of the members suggested changing guidance concerning short term rates. Per usual, this type of news was not well received by the market. It’s important to note that it was a small group advocating this, and the Fed is unlikely to take this action anytime soon.

New home construction fell 16% in January which may be a sign of a collapsing market. Some of that drop is, however, attributed to the weather.

The 2015 budget does not include any moves towards the superlative consumer price index or slowing the rate of entitlement increases by measuring inflation differently. Due to the politics of Washington D.C. in 2014, whether it’s in the budget or not is immaterial, as the consequences for what will actually happen will not be assumed by either party.

WhatsApp

WhatsApp was founded by Jan Koum and Brian Acton. Incorporated in 2009, revenue is reported to be around $20 million. Partly funded by Sequoia Capital, founder Jan Koum owns approximately 45% of the company.

The acquisition of WhatsApp by Facebook and the Twitter IPO are eerily reminiscent of the dot com bubble where overvaluation was pervasive. It is very hard to justify $19 billion for a messaging app aside from fear of the future. Facebook will be under pressure to prove this deal was worth it as popular social media companies, Instagram and Youtube, sold for one and $1.6 billion respectively. The question is: what does Facebook see down the road that isn’t apparent now? This seems very much like a defensive move.

The Market

While the door is open to raising rates now, it will only happen when the economy gains steam, as a growing economy is the driving force behind the market. Markets have given economic numbers a pass due to the weather. While blame can be placed on the weather, there has been weakness in the market when looking at employment and housing recovery numbers. While the unemployment rate was falling, the labor force participation rate was also falling. While housing prices were rising, building permits were falling. This market has not been built on fundamentals, and the weather just shined a light on the issue.

The Weather

Weather has had a meaningful impact on the market. What we have seen is not pinned up demand to be returned, but sales that have been lost for good. There certainly was excess momentum in the fourth quarter in both the economy and the markets, so there has been a little bit of a pull back in addition to the effects of the weather.

What I’m Doing

I’m optimistic about the market. There are things to buy, but there are a smaller number of things that are fairly priced. Things are frothy at this point; Tesla is a perfect example. Like WhatsApp, their valuation is laughably impossible mathematically speaking, and they are not alone. Amazon trades at 200 times earnings and Wal-Mart trades at thirteen times earnings.

Wal-Mart

Wal-Mart indicated that it’s having problems due to broader global economic concerns. This is important because Wal-Mart’s stock price tracks U.S. GDP. The company is an indicator of what’s happening in America. For the past few years, discount stores and low end retail have had problems maintaining profits. This is telling of the buying power of the American household. We haven’t even seen the pass through effects from $100 oil, and high natural gas which will pound the Wal-Mart consumer. For these reasons, I like high end retail or names immune from the low end consumer market.

Minimum Wage

In his State of the Union Address, the president pledged to raise the federal minimum wage from $7.25 to $10.10. The CBO stated that an increase to $10.10 would cost 500,000 jobs, but lift 900,000 people out of poverty. Sixteen million workers would be helped. Job loss could be anywhere from 0 to 1 million jobs lost. When the minimum wage goes up, firms will hire fewer workers. But the question is: how sensitive is that relationship? How much will firms respond? The number they chose for that elasticity is high which will lead to a somewhat higher job loss; however, 500,000 jobs lost are too many as I believe there will be a lower elasticity in the response to employers raising the wage. The real issue is whether it’s worth it to lift that many people out of poverty and help others for the tradeoffs.

Earned Income Tax Credit (EITC)

There is a significant problem in terms of opportunity and earnings for those at the lower end of income distribution. Perhaps raising the EITC would be preferable to raising the minimum wage. Raising the EITC rather than the minimum wage will not eliminate discincentives to work. As income increases, high marginal tax rates increase and various programs and incentives are phased out.

Gap

Gap announced they were increasing their minimum wage from $9 per hour this year to $10 per hour next year. Gap feels it will motivate their workers and put additional cash in their pockets which will help the broader economy and their own sales. We know raising the minimum wage will have unintended consequences. Factoring in the impact of product prices by the share of the workforce who would be experiencing a wage increase, there is directional pressure upwards but it is pretty inconsequential.

Ethnicity

We are certainly in a tough economy. There are some groups experiencing upward mobility at far greater rates than the rest of the country. Shockingly, these groups are the kids of poor and poorly educated immigrant parents, and they are all doing it more or less the same way.

What studies reveal is a generational decline in performance. An example is Asian Americans whom overall are 140 points above the national average in SAT testing; however, by the third generation they are even with the national average. Of immigrants, there is a steep rise in the second generation followed by a decline in the third generation.

These groups exhibit the three unlikely traits for success: superiority complex, insecurity and impulse control. Feeling “special” often leads to complacency. One must be insecure as studies reveal a lot of bad things result from feeling entitled. Impulse control is simply discipline. These traits are exhibited by Mormons, Indians and Persians, who on the whole, start earlier with focused and disciplined activities than the rest of the country.

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