Here’s a riddle: if Instagram is worth $1 billion, how much is Facebook itself worth? You might take a few seconds to think about that, because Mark Zuckerberg probably has. And if you really want to appreciate all the facets of Facebook-Instagram deal, that exercise may help you hold it up to the candle to see which way the light reflects.
Instagram is a great application with a devoted user base. Pretty much everyone has weighed in on what Instagram brings to Facebook, and it’s mainly true. The tech media has pointed out that Instagram is miles better than Facebook’s own mobile apps (it is); a whole lot of folks use Instagram and love it (they do); and the deal keeps a competitor like Google from buying it (it will).
Add up all of this, though, and the sum is less than its parts. Molly Wood of CNet expertly dissects the explanations, puncturing holes in each one. She points out that some of the things that Instagram offers — lots of users and a mobile app that doesn’t generate any meaningful revenue — are exactly what Facebook doesn’t need. By the way (at tip here to Bloomberg’s social media editor, Mat Yurow, who pointed this out) most of those users are already on Facebook.
So what’s going on here? A deal like the one that Facebook made for Instagram may not be whollu about getting the best technology for the lowest price. It’s likely just as much about enhancing the perception that Facebook is making big deals in a fast moving marketplace, because in a social media free-for-all, the bigger the deals you make, the more you’re perceived to be worth.
Every big Internet company has expanded by swallowing up nimble technology pacesetters. Of the deals that in retrospect turned out to be most significant, some — like Yahoo’s acquisition of Flickr for a price of $35 million — seemed inexpensive at the time. Others, like Microsoft’s purchase of Hotmail in the early days of the Internet boom, raised eyebrows but turned out to be bargains. What makes Facebook’s Instagram purchase perplexing when measured against those is that excellent as the Instagram app is, it’s one of many very good photo sharing applications. Facebook could have bought any of those for much less.
Getting the best technology for less, though, isn’t the whole story. The discussion of Instagram’s value takes place amid a hoopla about social media in which all the players are aware that the market is looking for every major Internet company to make its social media play, and is likely to cheer any deal that makes it look like Google, Facebook, or Apple are doing something big. The market prizes not small deals that get things done cheap, but big deals that make a splash. The amount that Facebook is paying for Instagram reflects the value that the investment world places on the entire sector, and that in turn helps establish the value of Facebook itself.
Venture capitalist Mike Maples, Jr. calls the stage of an investment wave when valuations start shooting up “the acceleration phase” of a technology boom. That’s the point at which market sentiment catches up to reality and starts running past it — and it’s where Maples thinks social networking is now, though Maples resists using the word bubble. At this stage, as Maples puts it:
Some founders and investors are better at playing the momentum game and this is where the Acceleration Phase comes into play. An opportunity is created because, even though valuations have become high, they are beginning to go even higher at a very rapid rate.
“Playing the momentum game” might be a good description of the Instagram deal. In this acceleration phase of the social media wars, the idea is to stay ahead of market sentiment, buying what’s rising in value in the anticipation that it will go even higher. Instagram made a huge profit for its investors have set a new, higher premium for mega-deals that can catch the public eye. If so, there will be more of those.
The bellwether here might be Twitter. No company with minimal revenue has had so much international cultural and political impact, or shines more brightly in the public eye. If Instagram is a comet, then Twitter is a star. And Facebook itself is a supernova. The more visible Facebook’s deals are now, the more explosive Facebook’s own entry into the public markets likely is likely to be later this year.
(Note: Bloomberg LP is an investor in the venture capital firm Andreesen Horowitz, a major backer of Instagram.)