Former web titan Yahoo (NASDAQ:YHOO) made headlines after announcing it acquired social media/blog site Tumblr for $1.1 billion, mostly in cash. Even though Tumblr generates little revenue, Facebook (NASDAQ:FB) did acquire Instagram for $1 billion (in cash/stock at the time) when the company didn't post any revenue. Given the amount of venture capital readily flowing into Internet media companies, a valuation that seems ridiculous in any other industry has simply become the going rate in tech (right or wrong).
Ultimately, if the present value of the future free cash flows generated by the acquired asset is greater than the price paid for the asset, we'd view an acquisition as value-creative. However, Tumblr's future free cash flow stream is so long in duration that any assessment of this deal will come out disappointing for Yahoo shareholders. Profitability is just too far into the future to justify the price tag paid today. In any case, the biggest question in the near term will be whether Yahoo is able to maintain Tumblr's success and popularity, a feat we think is achievable.
When we look at two of the largest, most-recent social media acquisitions, each looks quite different. As we mentioned earlier, Facebook paid (then due to stock price fluctuations) $1 billion for the mobile picture sharing app Instagram. Other than inciting rage when it attempted to take ownership of pictures, Facebook's rein over Instagram has been reasonably successful. Users have not experienced a flood of advertisements, and the only real difference is that Instagram's desktop experience has improved significantly (while posting pictures to Twitter via Instagram has become a less seamless experience). Small tweaks have been made to the user interface, but the Instagram of today is still basically the same as the pre-Facebook Instagram. We may see ads soon, but Facebook already has experience from its own mobile ad rollout, so this shouldn't rock the boat too much.
News Corp.'s (NASDAQ:NWSA) (NASDAQ:NWS) acquisition of MySpace tells a different story. News Corp. purchased the company for $580 million in July of 2005 near the peak of its growth. Although it became the most visited website in the US in 2006, Facebook eventually stole much of its user base, and the company has been in a downward spiral towards irrelevancy. MySpace bears little resemblance to its 2005 format, and it's safe to say the site is a shadow of its former self. News Corp sold the firm for a paltry $35 million in 2011.
Yahoo itself has had a storied past in making terrible acquisitions. Broadcast.com made Mark Cuban a sizable fortune, but Yahoo acquired the company for $5 billion in stock at the height of the tech bubble (1999) and did little to justify its lofty price tag; the service is now defunct. Yahoo also acquired GeoCities in 1999 for $3.57 billion. GeoCities was a bit of an early social network, as it was a small web development company that allowed users to create homepages and interact with others. Yahoo proceeded to change privacy and content ownership agreements, which in turn alienated the user base beyond repair. GeoCities is now mostly a relic of the early days of the web. Flickr was acquired in 2005 via a $40 million acquisition of Ludicorp. Again, Flickr was an earlier social network that ended up getting destroyed by a lack of innovation, fierce competition from Facebook, and poor investment in mobile apps (click here for an interesting read on Flickr's history).
One of the bigger fears we've seen is that Tumblr's engagement will decline. Users fear Yahoo will pull a "GeoCities" and ruin the company with ads, changes in policies, and a lack of innovation. This time, however, it could be different with Marissa Meyer as CEO. She comes from Google (NASDAQ:GOOG) and saw the path to help YouTube achieve monetization. She also knows the importance of mobile, an area where Yahoo is weak and Tumblr is relatively solid. In many respects, Tumblr may remain unchanged to a large degree.
Frankly, we're a bit more worried about competition, which has already changed several times. Xanga and LiveJournal may not have ever reached the same scale as Tumblr, but both had reins as important social blogs. Current competitor Pintrest fights for the same eyeballs, and we're confident new competitors will continue to emerge. Yahoo runs the risk that Tumblr is a fad that could burn out.
In our view, it is very hard to see how this deal works out positively for Yahoo from a financial perspective, especially since introducing ads seems to agitate users. With years of management not caring about earnings, a whole generation of web users has been conditioned to want things for free without ads subsidizing them. If Tumblr starts introducing ads that alter the user experience, we're confident another site funded by deep-pocketed venture capitalist funds will emerge and deliver an ad-free experience to steal users.
Yet, Tumblr might prove to be a bit stickier than we give it credit for, in which case ads wouldn't alienate users and Yahoo would be able to monetize its new acquisition. Will it be worth the $1.1 billion? That's impossible to know for sure at this time (given the long duration of Tumblr's future cash flows), but we're not too optimistic.
Additional disclosure: GOOG is included in the portfolio of our Best Ideas Newsletter.