Did Facebook overpay for Instagram?

If $1 billion seems like a lot, remember that information can sometimes be more valuable than revenue.

By MSN Money Partner Apr 17, 2012 12:29PM

By Aaron Pragnell

 

InvestopediaFacebook recently acquired Instagram for $1 billion. For those unfamiliar with Instagram, it is a smartphone application that allows users to take a photo and transform their photograph using 11 different filter effects. Users can then instantly share the picture through social media outlets such as Facebook, Twitter and Tumblr. Although the application allows users to follow other users, Instagram is widely used to only upload pictures to other social media applications.

 

So how does this application make money?
Well, at the moment it doesn't. Prior to the acquisition, Instagram had no business model to make revenue. The service is completely free and no advertisements are displayed to users, although there is definitely potential to monetize the company in the future, through ads or charging for additional effects. Instagram was surviving on venture capital funding.

 

History
Instagram is a company less than 2 years old, with zero revenue, yet Facebook felt the startup was worth $1 billion. Are we missing something here? Facebook was not the only company to put a high price tag on Instagram, as the company has been blessed with angel investors prior to launching.

 

The first round of funding came back in March 2010 when Instagram, then known as Burbn, received $500,000 in seed capital. The second round of funding was received about a year later, this time for $7 million. At the time, Instagram had attracted roughly 1.75 million users in the four months since the launch. Funding round three came just recently, when Instagram closed a $50 million deal just days before the Facebook acquisition. With approximately 35 million users, made up of roughly 30 million iPhone users and about 5 million Android users, obtained in six days, Instagram was valued at $500 million.

 

Did Facebook overpay?
This is a question that only time will tell. Facebook is a dominant force and photo sharing is one aspect it has always focused on, so acquiring the most popular photo sharing application should really not be much of a surprise. When you take a look at the price Facebook paid for Instagram compared with other tech acquisitions over the years, Facebook may not look so insane.

 

Facebook bought Instagram's approximate 35 million users for $1 billion, or just over $28 per user. Yahoo (YHOO) acquired Geocities in 1999 for $3.57 billion. At the time, Geocities had around 4.3 million users, meaning Yahoo paid about $830 per user. Skype was acquired by eBay (EBAY) in 2005 for $2.6 billion, working out to roughly $240 per user. Google (GOOG) bought YouTube for $1.65 billion, or nearly $49 per user, and Yahoo acquired Broadcast.com for $5.7 billion at over $10,000 per user. Comparing those numbers to the Instagram acquisition, it appears that Facebook may have got a bargain.

 

The bottom line
A billion dollars for a company that has not made a single dime still sounds ludicrous, but in today's age, information can sometimes be more valuable than revenue to companies such as Facebook. Instagram's user numbers have been impressive since inception and if the trend continues, Facebook may have made a wise strategic move. If anyone could have success taking a non-profitable popular application and monetizing it into a billion dollar corporation, Mark Zuckerberg would be the person, and it wouldn't be the first time he did it, either.

 

More from Investopedia

 

3Comments
Apr 24, 2012 3:46AM
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He didn't overypay at all, in fact, he underpaid for it.  Instagram and outfits like theirs is a threat to facebook's very existence.  When a better fad comes around, facebook could very well become a memory.  I remember Myspace, do you?
Apr 18, 2012 7:29AM
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If $1 billion seems like a lot, remember that information can sometimes be more valuable than revenue.

No, no it can't.  This is the exact thinking that inflated tech stocks so egregiously high in 2000.  Paying $1,000,000,000 for a company that makes no revenue, much less profit, is a terrible idea.  That cost a full year of earnings for Facebook.

 

If you want to invest in tech, look at companies that hire brilliant minds and actually make money.  Apple, Google, Oracle, and even stodgy old tech like IBM, Microsoft, and Intel are all better ideas than this future MySpace wasteland.

 

Avoid Facebook's IPO.  It will take less than two years for the market to realize this company is worth a fraction of its current $100 billion valuation.

Apr 17, 2012 10:29PM
avatar
Smile Overpaid is a loose most  ignored word in this day and age.
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