Facebook's Deal: 48 Hours and 1 Billion Dollars
George is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The acquisition of Instagram by Facebook, one which has stunned the world, was masterminded by Mark Zuckerberg over a span of 48 hours. Interestingly enough, before the offer, Instagram had received a fresh financing infusion that had valued the company at $500 million. Basically, Instagram doubled its worth in 48 hours while Facebook now faces the challenge of turning the acquisition from a liability into an asset.
Instagram is a company that has a nonexistent profit model and no source of revenue. Does the acquisition of Instagram sound familiar? In 2006, Google (NASDAQ: GOOG) paid $1.6 billion for a nascent Internet establishment with zero profits: YouTube. When news of the acquisition broke, many critics denounced the acquisition as hubristic and overpriced. Steve Ballmer, CEO of Microsoft, stated that "there's no business model for YouTube that would justify $1.6 billion." Now, YouTube is estimated to generate billions of dollars in annual revenue and was the second most-visited site of 2011. Of course, Instagram is no YouTube, but a central tenet of Google's motives to acquire YouTube can be applied to the acquisition of Instagram by Facebook: strategic fit.
Instagram is a major player in the mobile sharing network with more than 30 million users to date. Facebook has long emphasized the importance of gaining a significant foothold in the network through mobile applications, which it believes could become more prevalent than the desktop. Currently, only half of Facebook's nearly 850 million users use its mobile app which, combined with Instagram's recent move into the Android world, could present significant potential for gaining market share in the mobile sharing netowrk. Moreover, Instagram has long been the major competitor of Facebook in terms of mobile photo-sharing, so this acquisition, on the surface, seemed like a logical fit.
Yet there are significant potential areas of conflict that emerge with this acquisition. For one, there is the pressing issue of what Facebook will do with its own photo-sharing capabilities for Facebook and the Instagram photo-sharing system. After all, even though Instagram was bought out by Facebook, it still has the opportunity to take significant mobile market share away from Facebook's own photo-sharing system. Thus, this leads to the obvious question of whether or not Instagram will be integrated into the Facebook platform. Moreover, many of the Instagram users already access Facebook through their mobile devices, so Facebook is not reaching a drastically new consumer base to expand the usage of Facebook mobile apps. Facebook has basically paid $1 billion for capabilities it already had or could have easily acquired through much cheaper alternatives and for a 30 million+ customer base that has become extremely annoyed at the acquisition. In fact, Twitter has been ablaze with comments of Instagram users threatening a mass exodus from Instagram due to the acquisition. Many users expressed dispair at the thought of Facebook commercializing Instagram and lamented Instagram's loss of independence.
This apparent consumer backlash leads to a tricky conundrum for Facebook: any outright attempt to make Instagram profitable or significantly change Instagram, in the short term, has the potential to alienate Instagram's consumer base and damage its brand. Thus, Facebook has to make sure it doesn't do anything drastic in the short term, such as immediately pursuing advertising opportunities or even significantly molding Instagram to become more compatible with Facebook. As noted by the Wall Street Journal, Google's acquisition of YouTube was successful because Google kept out of YouTube's affairs and openly stated that profits from YouTube weren't their number one concern: Google wanted to develop YouTube's dominance in its respective market first and made significant effort to ensure it didn't slow down YouTube's growth charge. It seems like Facebook is taking note: during negotiations, Zuckerberg promised the Chief Executive of Instagram, Kevin Systrom, the ability to run Instagram as a separate company. Facebook has a long way to go to ensure its Instagram acquisition will pay off and it must tread carefully until the hubbub surrounding its acquisition settles down.
Facebook should do well to heed the concerns of Instagram users and adopt a long-term growth strategy instead of opting for a short-term profit drive to ensure maximum gain from the acquisition. As many as 70% of acquisitions fail. Acquisitions that were made through hurried deals have an even higher percentage of failure, as this often results from inadequate screening of the target company. For example, in 2008, Bank of America acquired Merrill Lynch for $50 billion in the deal termed by the Wall Street Journal as "a deal from hell." The time spent on the deal? 48 hours.
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