NEW YORK (TheStreet) --Facebook's (FB) $19 billion acquisition of WhatsApp indicates that the company's business model is very much in flux, as are founder and CEO Mark Zuckerberg's plans to generate revenue from its over 1 billion user social network. However, when Facebook does choose to focus on driving earnings for its stockholders, the company may look more like Netflix (NFLX) than Google (GOOG).
The key is to consider the industry that Facebook is seeking to disrupt and the means by which it plans to do so.
Netflix chose to upset the status quo of the cable industry by mutualizing streaming video programming through a growing user base, effectively using customers' fees to expand its programming. At the same time, Netflix relies heavily upon broadband and wireless networks built by those cable giants to transmit its content to subscribers. Netflix now is often the biggest driver of traffic on broadband networks on any given night. The streaming video specialist is also widely seen as responsible for flat to declining video subscriptions across the cable industry.
Mergers such as the proposed tie-up of Comcast (CMCSA) and Time Warner Cable (TWC) indicate that the cable industry is now adapting to some of the economic realities brought about by Netflix and other entrants in streaming video such as Amazon (AMZN), Hulu and even ESPN and HBO through their app-based functionality.
Facebook, with a growing base of assets that now is poised to include Instagram, Messenger and WhatsApp, seems poised to make a similar disruption in the wireless communications industry. In this instance, it's short-messaging-service, or SMS, which Facebook might use to disrupt, at a potential profit for the company's shareholders.
SMS has historically been a cash cow for the telecom sector. Transmitting text data over wireless networks costs little for carriers, and in the past, it was one of the areas where consumers paid the most in service and overage charges. Many remember the pre-smartphone era when text messaging cost money and could drive a phone bill to astronomical heights. Surprisingly, even today SMS remains a $100 billion global industry by revenue, according to calculations by Deloitte.
However, with the popularization of smartphone devices, SMS was one of the first legacy businesses that Silicon Valley startups targeted. Why pay SMS fees when an over-the-top messaging application could bypass a carrier's SMS service? Hence the popularization of services such as WhatsApp, Viber, Facebook Messenger, Kakao, LINE and even Apple's iMessage. Those services also offer better communications services than SMS, for instance video, an integrated interface with other smartphone content and increased overall messaging functionality.
Wireless carriers, of course, have seen the writing on the wall for years. Most data plans in the U.S. now include unlimited SMS. In the race for wireless revenue, carriers have focused elsewhere and particularly on the tiered pricing of data bundles.
But SMS's replacement, instant messaging apps like WhatsApp, may eventually become far more lucrative than the glory days of SMS.
WhatsApp, LINE and Kakao may bring innovation to mobile messaging, allowing for better dissemination of video and location-based content. Those apps may also straddle sectors like e-commerce and mobile payments. Facebook CFO David Ebersman referred to the $100 billion SMS industry as indicative of the earnings potential of WhatsApp - it wouldn't be surprising if that opportunity set expands in the wake of Wednesday's deal.
As with Netflix's disruption of the cable industry, some might look at Facebook's push into messaging as a missed opportunity for wireless carriers.
Cable had every opportunity to move into streaming video content, but video bundles are just too valuable to break. Wireless carriers, similarly, had every chance to conceive of a more productive messaging interface on smartphones but they clung to legacy SMS, which continues to profit primarily from non-smartphone users.
But even if Facebook succeeds in using WhatsApp to move into mobile messaging and ancillary businesses, wireless carriers may do just fine. After all, carriers like Verizon (VZ), AT&T (T) and T-Mobile (TMUS) have prioritized the pricing of data plans over other businesses like SMS.
In the end, carriers may find themselves in a similar situation to cable: consumers' rising reliance on wireless data could surpass lost SMS revenue. That doesn't seem too different from consumers' increasing reliance on their broadband networks as streaming video adoption rises.
Business models stemming from the shift from SMS to IMS may also resemble Netflix.
WhatsApp, so far, has generated its earnings from $1-a-year subscriptions. As Facebook takes on an ever expanded set of products, especially on smartphone devices, it's not too big of a stretch to believe the company could eventually move to some form of subscription model. Like Netflix, subscription revenue could be used by Facebook as a means to invest in the company's product offering and increase its relevance to users.
In 2013, Netflix crossed a threshold where it could use subscriber fees to profitably invest in original video content that consumers demanded. This year Netflix may prove the business model can pay off for its patient stockholders. Netflix's sharing of content costs with customers and its rising number of subscribers signal that new subscriber fees may increasingly fall to the company's bottom line. That would only increase the areas where Netflix can invest in the future.
It's not hard to see a similar path for Facebook, which, currently generates nearly $8 billion in annual revenue and $1.5 billion in profits from advertising. That advertising model currently most closely resembles Google and Twitter (TWTR). Wednesday's deal indicates change may be afoot
In fact, WhatsApp founder Jan Koum appears to bring a subscription mindset to Facebook through Wednesday's acquisition. To date, WhatsApp has generated its revenue through subscriptions. Nevertheless, Koum, who will join Facebook's board of directors, appears interested in playing a long-game on profits.
"WhatsApp really focuses on growth. Monetization is not going to be a priority for us, and this is why I actually respect Mark and his vision is that he takes a very long term on everything they do at Facebook," Koum said on a Wednesday evening conference call.
"They focus on something that is not just tomorrow, but something that's 5 or 10 years from now, and that's the same with our company. We always talk about where mobile is going to be, not today, not next year, but in 2020 or in 2025. And as we look forward to the next 5 or 10 years, 5 billion people will have a smartphone and we have a potential to have 5 billion users potentially giving us money through the subscription model."
On Wednesday, Facebook CEO Mark Zuckerberg made few concrete comments on how the company would seek to monetize its $19 billion WhatsApp acquisition. CFO David Ebersman, however, indicated that the company has a clear path towards revenue and profits that are important to shareholders.
"We've' always believed that if you bring a lot of utility into the marketplace, that sets you up to build a great business over time. If you think about messaging, it's the number one activity on smartphones. As Jan said, there's a 1.5 billion to 2 billion smartphones out there today. That's going to grow to 3 billion, 4 billion, 5 billion smartphones over time. And they're already at a place now where the messaging volume running through WhatsApp is nearly the same as the scale of the entire telecom SMS messaging volume, and that's a $100 billion business for carriers in terms of direct messaging fees. So this is a really valuable service that people are willing to pay for," Ebersman said.
"Given the size of their network and the value they provide to people who use their service, we're confident that over the long run, WhatsApp will deliver significant returns for our shareholders," he added.
Bottom Line: My bet is that Facebook's acquisition of WhatsApp firms up the company's thinking on some form of subscription model. Subscriptions paid by a rising number of users wouldn't be far off from Netflix.
--Written by Antoine Gara in New York