It’s like 1999 all over again. On Monday, Facebook announced it was buying photo-sharing company Instagram for US$1bn, netting the start-up’s cofounder, Kevin Systrom, a cool $400m. It’s paying over the odds, but the deal makes sense for Facebook ahead of its flotation on the stock market.
At first glance and based on the numbers, Facebook and its youthful CEO Mark Zuckerberg appear to be handing over an insane amount of cash and stock to buy Instagram.
The photo-sharing service, which, until recently, was available only for users of Apple’s iPhone — it finally launched a version for Google’s Android last week — has only 30m registered users, against Facebook’s 845m-plus active users. That means the social network is paying more than $33 per registered Instagram user. Consider, too, that Instagram, which is only two years old, has only 13 employees and that a recent round of financing, led by Sequoia Capital, valued the start-up at $500m. That is still an exceptional valuation, but half of what Facebook is bringing to the party. And, remarkably, Instagram has no discernible revenue model.
There’s no doubt that Facebook is paying hugely over the odds for Instagram. But as reports have noted, the $1bn valuation is 1% of Facebook’s projected $100bn market capitalisation when it lists. That aside, the deal makes sense just weeks before the company is expected to make its stock market debut.
In one fell swoop, Zuckerberg has addressed a number of potential threats and potentially solved, or helped solve, one of Facebook’s biggest areas of weakness: mobile. Instagram is built entirely on mobile phones rather than the PC-based Web and has an almost unprecedented level of engagement among its users. How Facebook leverages that without alienating loyal Instagram users is less clear. No doubt, though, Zuckerberg has a plan.
Instagram also gives Facebook access to a huge repository of photographs that users post in real time. As Zuckerberg knows only too well through Facebook, photos draw people in and keep them coming back.
Perhaps more importantly, the acquisition has also kept the fast-growing Instagram — the app is adding half a million users a week — out of the hands of archrivals such as Google and Microsoft, both of which have shown they are not afraid to take out their chequebooks when needed (witness Microsoft’s blockbuster $8,5bn acquisition of Internet telephony service Skype in 2011).
Last year, Google launched its own social network, called Google+, and is infusing social networking elements into its wide portfolio of products, including Gmail and Web search. Google+ is not the search giant’s first attempt at social networking — remember Google Wave and Orkut? But it is its most serious to date. As Facebook has continued to grow, Google has come to regard it as a serious threat — perhaps the most serious threat — to its bread-and-butter business of serving targeting advertising to Internet users.
Google co-founder and CEO Larry Page is reportedly concerned that people are spending more of their time online inside the Facebook ecosystem, where it is unable to serve them with ads, rather than on Google’s own properties or on the wider Web. The more time users spend on Facebook chatting to their friends, sharing content or playing games, the less time they spend looking at Google ads.
It was surely a matter of time before one of the giants of the Internet industry snapped up Instagram. The question for Zuckerberg must have been: why not pounce early with an offer that the start-up and its investors simply can’t refuse?
Analysts and investors are more likely to be asking whether another tech bubble is inflating. To be sure, Systrom and his Instagram colleagues must be in the mood to party like it’s 1999.
- Duncan McLeod is editor of TechCentral; this column is also published in Financial Mail
