For years, it's been a popular pastime to decry the use of mergers and acquisitions (M&A) as a colossal, ego-inflating, comp-expanding, waste-of-shareholder-money exercise. Most of these charges are either wildly exaggerated or absurdly simplistic. M&A is a necessary means for companies to grow, particularly in a world so driven by change. Failures are unavoidable -- it's not easy -- although measuring what's exactly a failure or a success given the complexities of large corporations is pretty difficult. But it's very true that in overheating markets, when currency in the form of shares is highly inflated, lots of lousy, value-destroying deals can get hatched. This is particularly the case in intensely competitive technology industries, where the value creation of a given deal may lie not in the current organization but in a technique, a process, a piece of intellectual property still undergoing gestation: that is, in an opaque future. Thus the truism beloved of Warren Buffett: In M&A, there's nothing riskier than tech deals.
And then there's Facebook and Instagram. Facebook is famously paying a cool billion dollars for the two-year-old app-based photo service. Instagram has 13 employees, 30 million users and no revenues. Facebook's Mark Zuckerberg decided the social media giant absolutely had to have the startup, and took a year's worth of cash flow and offered it up, about twice Instagram's recently closed Series B venture round valuing the company at $500 million. There was no indication of other bidders, though everyone seems convinced that a Google or an Apple was lurking out there ready to make its own pre-emptive bid. In the developing meme about the Instagram deal, Zuckerberg didn't have a choice: He had to strike. It was eat or be eaten. The sheer uncertainty of the social media landscape can't tolerate hesitation; it demanded action. In California, venture capitalists, investment bankers and analysts can't praise the deal highly enough (of course, they all profit from the resulting euphoria). Zuckerberg showed brilliance, they said, by recognizing Instagram's potential and making the bid -- despite the fact that this will further complicate Facebook's enormous and much-hyped IPO in a month or so.
That alone should cause one to pause along with the profound faith in a young CEO who hasn't done much dealmaking. The issue here is not that Zuckerberg made a good decision or not. We'll find out in time whether Instagram is a PayPal or a Skype (both eBay acquisitions: the former, as The New York Times lays out today, a big success, the latter, a big loser) or a Flickr (a Yahoo! bomb) or a Flip (which Cisco, a regular and expert user of M&A, shut down last year). Instagram most closely resembles some of the giant telecom deals from before the bubble burst in 2001, particularly in the size of the deal and the tiny number of employees. Billions of dollars in those deals were written off when the market collapsed. And let us not wallow in AOL-Time Warner again.
No, the issue with these sorts of deals is how any investor can make a rational judgment about a) whether this deal makes strategic sense, or b) whether the price makes any sense at all. The two are related, of course. The view from Silicon Valley seems to be that Facebook had the money so why not spend it. Cutting-edge tech companies need to bet big and make "strategic deals," that is, deals that can't be be valued -- the feeling is that Zuckerberg is a genius and if he doesn't know what Facebook needs, then nobody does. Facebook isn't even public so Zuckerberg can spend his money any way he wants and the reaction of users and the tech community seems to be so positive it can't go wrong. Well, of course, it can go wrong. Crowds change their minds, and Instagram's users in the Twittersphere don't seem to want to be enveloped into Facebook world, though this is about as scientific as a finger in the breeze. Apps (and social media sites) come and go. Instagram has very few employees, all of whom are now loaded with dough. They may stay and develop the product -- though no one seems to know how it'll make money -- or they may drift off to start new companies or go into politics or try venture capital. There seems to be few barriers to entry in the app world, and it's hard to imagine that Instagram, as nifty as it is, is unassailable. Moreover, it's unclear whether Instagram boasts the kind of network effects that makes PayPal, YouTube, Google, Microsoft, Apple and Facebook so formidable. Remarkably, few seem to be asking.
Again, this could turn out to be a fabulous deal. But this is the kind of deal that gives M&A a bad name. The notion that Zuckerberg can spend "his" money any way he wants is not only wrong -- it's not really his -- but about to become a real problem when public investors buy shares. (Substitute, say, Bank of America for Facebook and see how that works.) A billion dollars remains a big number, no matter the market cap. Moreover, it's pretty clear, as the Financial Times' Lex column pointed out Tuesday, that despite Zuckerberg's statement that this is a one-off deal, what it really suggests -- and that the tech crowd confirms in its comments -- is that there could well be other Instagrams to be scooped up. Facebook is implicitly admitting that in a burgeoning and remarkably fluid app world, it can't really go it alone: It needs to buy and buy and buy. Again, that's not a shock (Google has been a busy buyer) -- though Zuckerberg, prepping for public company status, should be more careful with statements about one-offs he may have to take back, and that will hurt him with investors once he goes public.
Will this deal hurt Facebook if it never works out? Not really. It's just a write-off, which Facebook can shrug off. By then there will be new hot apps, racking up millions of grazing users. But what this deal tells us most clearly is just how risky the Facebook enterprise is. For Zuckerberg to make a pre-emptive bid that's twice the venture valuation from two weeks ago -- and one a month before a public offering -- suggests two things: either he's undisciplined with all that money (were there negotiations or due diligence? what's the breakdown of cash and shares?) or that the powerful network effects that keep users coming back to Facebook may not be as strong as a relatively obscure two-year-old startup's app.
Is this a sign of a bubble? I don't believe that, unless you define bubble in a very narrow sense. Social media is clearly heating up, but for rational reasons: new devices, new services, new apps, an exploding audience. Instagram might look like an old dot-com -- lots of users that may come or go, no viable revenue model -- but Facebook does not: Like Google, it has found a way to make a lot of money. But you don't have to have a full-blown bubble to lose your discipline as a buyer. You just need the sudden appearance of a lot of cash. Which is how M&A gets a bad name.
Robert Teitelman is editor in chief of The Deal magazine.
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Billion's a lot & still way high, but we don't know, as you mention, the cash/stock partition. Investors in the ipo will be people already familiar with that partition and who have already booked shares. They won't stay in those hands for long as the millions will be hard to resist. Seconday investors will be even more concerned, theoretically, but ego and enthusiasm should keep the price high.
I agree with the risk assessment. They may have learned from the once inevitable-looking Friendster, but to have to survive by buying not revenues but options on revenues that are many derivatives away from cash flows is a risky thing, inherently.
Above all, I think the signal here is of a new currency. I'm surprised the analysts haven't comprehended: 30 million users. Instagram was a well-incubated proposition amongst folks who share dna just about. Considering the overhead (near nil), I imagine they're doing better than the vc method of putting cash down for less close people and hoping for a winner out of 20.
This currency seems foreign to folks in terms of the revenue argument. Instagram has no revenues? Today, People Are Currency. Wholesale cataloging/selling of data is solid, usu. hidden revenue stream. Advertisers pay for customized tranches as the web is not really new in that it turns on the cpm model.
As long as fb amasses people, s-valley is cool with that. Thanks for this piece. Lot to think about.
If there is anything at all that Mr. Rumpelstiltskin taught us, it is that "all that glitters is not gold." Thirteen people came up with an idea, and one fellow who by all accounts ought to be thinking about finding a real-job after college somehow has enough rock-solid cash in his hands to pay every one of these thirteen people $76,923,076.92 =apiece= for it.
Uh huh. I was born, but not yesterday.
Spin your golden-glitters any way you want to. This little red hen ain't gonna have any part of it.