Facebook is Buying Continued Relevance

When Facebook was going public they bought Instagram for around a billion dollars. Instagram was succeeding at something Facebook was trying to do - get teens to engage with a photo-sharing and social network app on mobile. Facebook paid about 1% of its market capitalization to own this emerging company. Later data revealed that it was definitely a good move - people really like Instagram.
   
More recently, they paid a lot more for Whatsapp, a messaging app founded in 2009. They paid $16 billion, or $19 billion dollars when restricted shares that will paid out as retention bonuses are included. That works out to over 10% of Facebook's current market capitalization.  Whatsapp was starting to beat Facebook in the messaging space - in most of the developed world outside of Japan and Korea Facebook and Whatsapp are the number one and number two messaging apps (It's unclear if counting Apple's iMessage as a separate app would change the math significantly).

There is no question that owning the messaging and mobile photo sharing spaces is what Facebook needs to do. And the mobile messaging space in particular appears to be very profitable. Line has been monetizing their user base quite well recently. But the big question is whether or not these nascent competitors that Facebook bought will continue to dominate the market for the foreseeable future.  

Zynga tried to implement the strategy that Facebook is applying when they bought Omgpop, the company behind the popular app Draw Something. Zynga wanted to get a foothold in the mobile gaming space but found out that success was not repeatable. While the analogy is worrying considering Zynga's subsequent troubles, Facebook is in a signficantly better position. With Whatsapp the network effects are stronger and there is no pressure for Whatsapp to create any other hits - they just have to outcompete other messaging apps and monetize their current business. 

But if consumers move on to other methods of communication in a few years, Facebook will have to buy the new competitor in the space if they are unable to innovate successfully. The social space is adapting to new technologies and is changing much more quickly than other areas. If Facebook needs to continue to buy competitors to keep their mindshare with consumers constant they will dilute their shareholders before they are able to deliver significant value. They might also start to attract the attention of the FTC.

One thing that this acquisition highlights is just how technology companies are threatened by the changing technology landscape. An investor who is bullish on technological innovation should be wary when buying the current technological incumbents - these incumbents risk either be outcompeted by new entrants or having to buy them at inflated prices.