A new article on the Harvard Business Review website argues that the value of Facebook's acquisition of WhatsApp isn't so mysterious and dot-com-crazy as the knee-jerk reaction of many observers suggested. Its author, Robert Fabricant, the vice-president of creative for high-tech design firm Frog Design, writes that the purchase isn't much different than more concrete acquisitions of unexploited assets in other segments of the economy – like, for instance, an energy company buying shale oil fields.
The shale parallel may, indeed, be an apt one. But that doesn't mean Facebook investors should take much comfort from it.
The shale plays and the WhatsApp acquisition, as Mr. Fabricant points out, share some key traits in their business rationale. First is the concept of "option value." In this case, the term refers to the notion that buying an asset that has yet to be exploited gives the purchaser new options by which to grow his or her company – while simultaneously starving competitors of a potential option, forcing them to look at less attractive options. Essentially, he argues, Facebook has acquired "reserves" that it can develop in the future – much as oil companies buying up shale properties are acquiring reserves for future production.
The other key similarity is that, like shale, the key to unlocking the value of the WhatsApp reserves lies in technological advancement. Shale properties didn't look worth much until the technology (horizontal drilling and fracking) made it possible to unlock the oil and gas trapped in the ground. Think of WhatsApp as a rich vein of mobile social communication, just waiting for Facebook to frack the enormous financial value out of it.
There are, of course, problems with the analogy. Oil and gas are finite resources, and not easily replaced with alternative energy sources. New social network apps, on the other hand, are being created every day – and once a better mousetrap is built, the old one may be in trouble, whether or not its buyer has yet extracted $19-billion (U.S.) of value out of it.
But the bigger problem may lie in the assumption that just because the reserves are there (and with WhatsApp, there are no geological tests to establish this), it follows that you can extract them at a profit. This is the lesson the market has learned from shale oil's older cousin, shale gas.
It was not long ago that natural gas from shale was all the rage, and companies worldwide were scrambling to secure shale gas properties, bidding up land prices to unheard-of heights. Indeed, the buying frenzy looked not unlike the dot-com frenzy of the late 1990s, as companies paid ever higher prices for assets that hadn't yet proved they could generate a dime of profits.
And many haven't. It turned out that even with the technology, many shale properties are uneconomic to produce. Drilling for shale gas in the United States has declined sharply, as producers, having exploited the easiest and most cost-effective reserves, are increasingly inclined to leave the rest in the ground. The reserves are still there, but they may prove impossible to exploit at a profit. For all intents and purposes, they may as well not even be there. And companies that bet big that they could unleash all that value that was assumed to be there – most notably Chesapeake Energy Corp., the biggest gambler of the bunch – have suffered billions in writedowns as they have been forced to acknowledge that they overvalued the assets.
Facebook's WhatsApp purchase looks similarly fraught with peril. As the shale gas boom has reminded us, not all reserves can be unlocked profitably – and counting on technology to make the impossible possible can be a costly leap of faith.