Finally the Federal Trade Commission gave Facebook (FB) an "ok" to buy Instagram. Initially, the cost of the deal for Facebook was $300 million cash and 23 million shares of Facebook. At the time of the deal, 23 million Facebook shares were worth $700 million, bringing the deal to $1 billion. Today, 23 million Facebook shares are worth $437 million, bringing the deal to $737 million.
Instagram is a mobile application that allows users to alter and share their photos within their social network. The problem with Instagram is that it was never able to monetize its member base. Basically, the company was suffering from the same problem Facebook is today. The company didn't even have any plans or idea about how to monetize its members and it practically had zero revenue and zero earnings at the time of the acquisition. The company was just a start up with less than 10 employees. Luckily, they monetized their company by selling it to Facebook. Basically, Facebook spent $1 billion on an investment with zero return on investment at the moment.
Instagram's product is nicely integrated with Facebook's website and Facebook was able to eliminate a potential competitor by acquiring Instagram. This is pretty much the only benefit Facebook got from acquiring Instagram so far, and it may not necessarily be worth $1 billion (or even $737 million).
Facebook raised a good amount of cash during its IPO and the investors expect the company to use this cash to a good use. Many of the company's investors are already disappointed with the company's performance after the IPO and there is no need to make them even more upset by wasting the IPO money on projects with nearly no return on investment. Mark Zuckerberg's acquisition of Instagram is worrisome because it shows that he won't think twice about putting loads of money behind any idea he thinks might be cool.
The soon to be previous owners of Instagram are probably upset that Facebook's value went down so much so fast, but again they must be happy that they were able to sell a company with practically zero revenue for a large sum. Several years ago when Google bought YouTube, it paid $1.5 billion in cash and stocks. Today YouTube's annual revenue totals $3.6 billion. This alone can tell us how bad of a deal Facebook got from Instagram. I wonder if the recipients of those 23 million Facebook shares will dump their shares as soon as they receive the shares.
How exactly will Facebook monetize Instagram? No one really knows the answer. Instagram is a mobile-only application and it is very difficult to put any kind of advertisement in a mobile application due to the small size of the screen. Facebook couldn't make members pay to use Instagram either, because a lot of free alternatives would pop up in no time and steal Instagram's members. Instagram is a very simple application and it is easy to replicate, therefore no one would really pay for a membership at Instagram.
Facebook continues to be challenged with the delicate balance of making its advertisers happy and making its members happy. Having too much advertisement would turn off the members and having too little advertisement would upset the shareholders who want to see return on their investment. Facebook will have to experiment with a variety of different advertisement ideas and settings to see the ideal mix.
As of right now, I continue to rate Facebook as "don't touch it with a 20-feet pole." Not only I don't advise buying the stock, I also don't advise shorting it. In the stock market, a share can go up for a long time with little to no reason. Who knows; Facebook might get pumped in the next month or two and see its share price doubling again. We've seen this with Amazon (AMZN), Chipotle (CMG) and many others before. In the short term, the market doesn't have to make sense. For the time being, I will continue to stay away from Facebook.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
