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Revisiting capex

When we last examined Facebook’s capex, we observed that year-over-year the company’s spending on property and equipment has been declining. We concluded that the reduction in network infrastructure spending reflected a maturation of the company’s infrastructure and platform. Facebook’s somewhat modest FY 2013 capex bears out this thesis. However, Facebook’s WhatsApp acquisition raises questions about capex going forward.

Facebook estimated that capex in 2013 would grow at only 12%, totalling an estimated $1.8B (later revised down to $1.6B). As we noted previously, this would reflect a slowing capex growth rate. In fact, a combination of efficiency investments on the hardware and the software side have further driven down realized capital spending in the year. According to its 10-K, as a result of these investments, total capex was a more modest $1.36B.

By tracking the historical cost of Facebook’s property and equipment we can see that the majority of capital spending is directed to growing or maintaining the company’s network infrastructure. This includes the purchase or lease of servers and other network equipment, and building costs for Facebook’s growing list of data centers. This also explains the bulk of the decline in capex over the year, with only a small increase in nominal cost in Q4 2013.

Facebook's quarterly property and equipment historical cost

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The Case for WhatsApp

Facebook recently announced its acquisition of WhatsApp for $16B in cash and stock, plus another $3B in RSUs.1 The acquisition was not surprising; mobile messaging is clearly of systemic importance to any mobile platform (except according to Twitter). However, the terms of the acquisition elicited some surprise, given Facebook’s recently failed attempt to acquire SnapChat for a more modest reportedly $1B. Putting aside its valuation for now, we should realize that WhatsApp’s strategic value to Facebook is substantive:

One might be tempted to define the acquisition in terms of technology or intellectual capital (32 engineers); however, WhatsApp’s value to Facebook is properly defined as user acquisition. The messaging app boasts 450M monthly active users, with an estimated 315M daily active users. This puts WhatsApp almost on equal footing with Facebook in terms of its active mobile user base. The significance of this position cannot be understated.

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Incentives and the Mobile Payments Problem

We last looked at Facebook’s payments business in Q1 2013, where we observed a slight increase in payments revenue. Payments in the second and third quarters remained relatively flat across regions, reflecting seasonality. Facebook’s payments revenue in Q4 appears to be down 6% year-over-year; however, this is due to last year’s deferred revenue recognition. Despite the expected seasonal increase in Q4, payments growth actually saw approximately 27% growth over the year ago quarter.

Facebook’s payments business earned $241 million in the quarter, making up a modest 9.3% of its total $2.58 billion in revenue in the quarter. The lion’s share accrued to North America with $138 million, an approximately 6% increase over Q4 2012. Facebook’s largest year-over-year increase occurred in Europe, where revenue increased by 21%, from $56 million to $69 million. Payments revenue in Asia and rest of world regions remain relatively unchanged year-over-year.1

Facebook's payments business revenue by region

According to the company, after adjusting for a deferred revenue recognition, payments revenue from games grew 8% over the year ago quarter. Facebook noted that games revenue, which comprises the majority of its payments business, is limited to its desktop user base. And, that the desktop segment of its user base is declining. Facebook’s tacit admission that, despite games revenue growth, its payments business effectively monetizes an increasingly less important segment of its user base is telling.2

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Continuance - Facebook Analysis by . @jonmilani. Copyright © 2014. All rights reserved. Hosted by (mt) Media Temple.