The internets are ablaze with news that Instagram has been purchased by Facebook for a cool $1 Billion. With a B. Or double what it was supposed to be valued at going into the next round of funding. Now, I have spent the last week and a half ranting about the stupidity of Instagram being valued at half a billion, so clearly I must be absolutely nuts after hearing about the purchase plans, right?
No, actually. In fact, I think Facebook buying Instagram at $1 Billion now was a pretty smart move that may pay off big. Here’s your 2 minute analysis.
1) Facebook derives the majority of it’s value from selling advertising and from fractional payments on their e-currency that’s used for various games and apps. Both of these revenue streams depend entirely on a large and ever expanding user-base to grow. Since FB is both near social media market saturation and since there have been numerous startup networks slowly leeching traffic and users from FB, a quick injection of 12 million users is just what Facebook needed. Moreover, at a total cost of $1,000,000,000, this breaks down to a CPA of just over $83 per user. $83.34 to be more exact. This is not a terribly high cost per acquisition. Especially given that the average lifetime value of a FB user to FB is significantly higher.
2) A private investment firm would not have been able to leverage an existing revenue model in order to roll Instagram into profitability nearly fast enough to make the company worth the $500 million valuation. Let’s face it, no one at Instagram had any idea on how they were going to monetize the thing, let alone make a profit. Oh sure, they kept talking about having a plan. In start-up terms, “I have a plan to make money with this but I’m keeping it secret for now!” is code for “Halp! I have no idea what I’m doing and my pay-checks are starting to bounce.” To a private investment firm, Instagram was not worth half a billion. To Facebook, which has demonstrated an almost diabolical ability to turn anything into a revenue stream, Instagram really does represent a potential for significant earnings.
3) Facebook is about to go public. This has two impacts. The first is that very shortly, the Zuck is going to have investors crawling up his…ahem…timeline, demanding some sort of accountability for large acquisitions. It was a buy it or lose it moment, and one thing we’ve seen over the years is that when Facebook decides it wants something, it moves fast to get it, and it doesn’t like letting things go. Had FB allowed itself to be dragged into a bidding war by offering less money, it might have prolonged the process to the point where they would have either had to delay the IPO, or risk loosing the bid because of shareholder interference. The second impact is…
4) FB is already set to IPO at a ludicrously high valuation. Adding a company with 12 million active subscribers that has now been de-facto valued at $1 Billion will do nothing but drive their initial share price higher. It’s the difference between the Zuck being able to purchase Africa and being able to purchase Africa AND South America, and then building a solid gold tug-boat to ferry him from one to the other.
So while I am a little stunned at how high these valuations have gotten, and while there is definitely a bubble inflating rapidly, I do think FB buying Instagram for double it’s valuation was a smart move that will probably pay off fairly well…until the bubble pops, but by then no one involved at the top will care anyway, since it’s difficult to see a financial meltdown from the cabin of your personal solid-platinum zeppelin.
Update: Instagram may now actually be up to 50 million users according to TechCrunch, dropping FBs CPA to a scant $20. Which may make this one of the most successful user-base purchasing decisions ever.