Facebook scared of the Internet

John Gapper, Financial Times

It is no wonder that Mark Zuckerberg got so defensive this week. As he was paying $1bn to eliminate the threat to Facebook from Instagram, an 18-month old photo sharing site, the web’s former giants were being humbled.

Yahoo, which unveiled another reorganisation under its fifth chief executive in five years, and AOL, which sold a portfolio of 800 patents to Microsoft for $1.1bn, are under attack from hedge funds. Both are worth a fraction of their value during the 1990s internet bubble. (AOL has spent $2.3bn on acquisitions since 1999 and now has a market capitalisation of $2.3bn.)

Silicon Valley was always competitive but barriers to entry in the late stages of the social network boom are so low, and capital so plentiful, that creative destruction is on fast-forward. If Facebook, which is about to launch its initial public offering, will pay $1bn to neutralise Instagram, how much are Path, Pinterest and others yet to be invented worth?

Since Instagram has no revenues at all, it is impossible to judge exactly how much Mr Zuckerberg overpaid for a single app that became more fashionable than his own creation.

But we know what he’s scared of – repeating the fate of many consumer internet companies (including social networks such as Bebo, which AOL bought for $850m in 2008 and sold last year for $10m). They can suddenly gain millions of users and huge valuations – and just as abruptly lose appeal and implode.

Until Instagram, Facebook had taken the puritan approach. When it bought start-ups such as MailRank and Hot Potato, it integrated them into its existing services and kept the engineers, a deal strategy known as “acqui-hiring”. Instagram’s size, and the fact that it works with competitors such as Twitter, made it different.

Read the full analysis at the Financial Times, as well as Frédéric Filloux’s commentary on the deal at Monday Note, where he looks at Instagram’s lack of an monetization strategy, and that trying to apply any cost per user metric is bogus.

Being unable to project any sustainable revenue mechanism makes such a valuation process completely pointless. In Instagram’s case, the only way to come up with a price tag was guessing the amount of money a small group of suitors–Facebook, Google and Twitter–might be willing to cough up for Instagram’s eyeballs.