Facebook Bulls Buy WhatsApp Deal With 1.3 Million Calls - Businessweek

Count options traders (FB:US) among investors who have managed to get past concerns that Mark Zuckerberg is overpaying for WhatsApp Inc.

They've bought and sold 554,000 bullish calls on Facebook Inc. (FB:US) daily since Feb. 20, up from a 2014 average of 247,000, data compiled by Bloomberg show. The total reached 1.3 million on Feb. 20 and 21, higher (FB:US) than any time in the past four months. More than half of those were out of the money, representing bets that shares of the social network will keep climbing after they quadrupled since September 2012, the data show.

While Facebook's $19 billion purchase of the mobile-messaging application compares with projected annual sales for WhatsApp of about $1 billion, the valuation did little to hinder bullish wagering on shares that have already rallied 29 percent in 2014, according to Stephen Solaka, who helps oversee about $130 million including Facebook options as managing partner of Belmont Capital Group in Los Angeles. Bullish options volume has outpaced bearish by about 2-to-1 since the deal was announced after the market close Feb. 19.

Traders "shrugged off the size of the deal and the stock is acting like it's a good thing," Solaka said in a Feb. 24 phone interview. "People who are on the short side could be buying call protection or they could just think the deal is undervalued and it's a huge thing for the company."

Chief Executive Officer Zuckerberg said at the Mobile World Congress in Barcelona yesterday that WhatsApp was "worth more than $19 billion." With about 450 million members, WhatsApp is growing by about 1 million every day. Zuckerberg said last week that his goal (FB:US) is to bring WhatsApp subscribers to 1 billion.

Building Infrastructure

"As Facebook works to connect the entire world and to build the infrastructure for a global community, WhatsApp will clearly help accelerate our progress," Zuckerberg said on a Feb. 19 conference call.

The Facebook co-founder, who also bought photo-sharing service Instagram for about $700 million in 2012, has been adding applications such as messaging and news to court smartphone and tablet users.

Calls with a $75 strike price expiring in March were the most-traded on Feb. 20 with more than 68,000 contracts, or about 7 percent of the daily total. On Feb. 21, March $70 calls were the most popular, changing hands almost 82,000 times, or 10 percent of the day's aggregate volume.

About 544,000 bearish contracts changed hands during those two days, or about 42 percent of the volume in calls, data show.

'Intense Demand'

Facebook bulls buying calls were responsible for the jump in trading, according to Henry Schwartz of Trade Alert LLC.

"Option traders appear to like the deal," Schwartz, president of Trade Alert, a New York-based provider of options-market data, wrote in a note to clients on Feb. 20. "Upside calls in Facebook seeing intense demand after acquisition."

The buying has pushed implied volatility (FB:US), used to gauge the cost of options, up 23 percent since Feb. 19 to 47.87 yesterday, according to data compiled by Bloomberg on three-month contracts with an exercise price closest to the stock.

Calls with an exercise price 10 percent above the shares cost 0.36 point more than puts 10 percent below on Feb. 21, data compiled by Bloomberg on three-month options show. That's a reversal from a week ago when puts traded at a 1.2-point premium to the bullish contracts.

Tucker Bounds, a spokesman for Menlo Park, California-based Facebook, declined to comment on the company's options trading.

99 Cents

WhatsApp, based in Mountain View, California, is popular in a crowded field. It competes with apps from Twitter Inc., Kik Interactive Inc. and Snapchat Inc., a startup that rebuffed a $3 billion Facebook bid last year. Similar apps include Tencent Holdings Ltd.'s WeChat in China, KakaoTalk in Korea and Line in Japan -- and Facebook's own Facebook Messenger.

The service is displacing traditional text-messaging as the preferred method for young people to stay in touch on mobile devices. Unlike conventional text messages, which people pay for through their mobile-phone plans, WhatsApp's are free for the first 12 months; after that, a subscriber pays 99 cents a year.

At a fee of 99 cents a year, 1 billion paying WhatsApp users would translate into about $1 billion in annual sales, bringing the projected revenue multiple that Facebook is paying to 19, data compiled by Bloomberg show. Only Vertex Pharmaceuticals Inc., a maker of drugs for Hepatitis C, trades at a higher ratio of estimated sales to price among stocks in the S&P 500, according to data compiled by Bloomberg.

'Unambiguously Worse'

Facebook trades (FB:US) at 56.5 times projected earnings, compared with an average price-to-earnings ratio of 15.4 times for technology companies in the S&P 500, according to data compiled by Bloomberg. Google Inc. shares are valued at 23 times projected earnings, while LinkedIn Corp.'s multiple is 123.5 times, data compiled by Bloomberg show.

The WhatsApp purchase is "almost unambiguously worse for fundamentals," Brian Wieser, an analyst at New York-based Pivotal Research Group LLC, said in a Feb. 24 phone interview. Wieser downgraded his rating on Facebook shares to hold on Feb. 20. "This doesn't have much in the way of revenue and it's a lot of capital. I would argue that investors are focused on the story more than anything."

The number of calls outstanding climbed to more than 2.1 million on Feb. 20, or 67 percent more than put open interest, data compiled by Bloomberg show. Among the 10 most-owned (FB:US) contracts, eight were bullish, with March $70 calls having the largest ownership at the close yesterday.

Volatility Gauge

The Chicago Board Options Exchange NDX Volatility Index, which tracks the cost of Nasdaq-100 Index options, lost 3.6 percent to 15.24 yesterday. The CBOE Volatility Index of S&P 500 options prices known as the VIX (VIX) fell 3.1 percent to 14.23, for a third day of declines. Europe's VStoxx Index dropped 1.1 percent to 16.54 at 11:44 a.m. in Frankfurt today.

The bullish trading in Facebook options is justified because WhatsApp offers a large mobile user base, low costs and considerable growth, according to Scott Kessler, an analyst at S&P Capital IQ Inc.

"People realized that it's a large, scalable business with a lot of possibilities," Kessler, who rates Facebook share hold, said by phone in New York on Feb. 24. "Facebook is using stock as currency, the shares have performed very well over the past year, and they are addressing further issues related to perceived weaknesses related to communications platforms pertaining to mobile."

To contact the reporters on this story: Callie Bost in New York at cbost2@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

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