A cool $1 billion for a dozen people, an app and no revenue model. A ridiculously high valuation for two-year-old photo-sharing startup Instagram Inc.? Not if you ask Silicon Valley venture capitalists, bankers and analysts, who viewed Facebook Inc.'s $1 billion acquisition of Instagram, which lets users easily share pictures they've snapped with their mobile phones, as a smart move to help it maintain growth.
When asked if the price tag raised any concerns, one technology investment banker simply responded: "Seems like a deal to me."
It might be a slightly blithe comment, but it captures the sentiment about the deal, announced by Facebook founder and CEO Mark Zuckerberg in a status update on the social network Monday. In fact, it was tough to elicit much criticism about the transaction, Palo Alto, Calif.-based
To a company with $3.9 billion in cash that's a month away from raising upward of $10 billion in an initial public offering that could grant it a valuation as high as $100 billion, a pricey deal that could help address a glaring hole in a key area -- mobile -- and keeps a leading, fast-growing startup away from rivals is a no-brainer.
"Facebook is a sharing platform, and they need to maintain their leadership there," said Gus Tai, a general partner at Menlo Park, Calif.-based VC firm Trinity Ventures. "Instagram is a leadership app, and makes every smartphone a point of entry and differentiation for Facebook."
Tai's firm was not among those that backed Instagram, but the VC had a somewhat similar experience, having seen Trinity portfolio company Photobucket Inc. fetch $300 million when the online photo-sharing service was acquired by MySpace parent Fox Interactive Media Inc. in 2007. (Interestingly, angel investor Chris Sacca, an early investor in Instagram, also backed Photobucket.) Tai said that the price Instagram fetched, when viewed through a strategic lens, makes perfect sense.
"When a company acquires strategically, it believes that the target will produce more value than the amount paid," Tai said. "Will Instagram help accelerate Facebook's value by 1%? I say yes, and it has the potential to be even more valuable than that."
Ovum analyst Mark Little wrote Tuesday that the $1 billion agreed-upon price tag is highly inflated in terms of the usual multiples paid -- a revenue multiple is impossible to come by, since Instagram has no revenue. Yet there is a competitive element, in that the other companies that may have taken an interest in the startup -- Apple Inc., Microsoft Corp. and Google Inc. -- each have huge cash piles.
"Rather than a bubble, these 'inflated' prices are perhaps better described as a temporary market condition centered around a limited number of acquisition targets perceived as valuable and driven by the cash of four high-rolling Internet giants," Little wrote.
This kind of high-flying deal isn't really new. The obvious comparison that has been making the rounds is Google's $1.65 billion acquisition of online video site YouTube in 2006. It was Google's biggest transaction at the time, yet YouTube, which employed 65 people at the time, was not producing much revenue at all. It was, however, growing very fast, and some analysts estimate that the revenue derived from YouTube is on track to clear $1 billion in 2012.
Menlo Ventures managing director Shervin Pishevar also pointed to the $1 billion Yahoo! Inc. offered Facebook in 2006 when the social network was bringing in revenue.
"In the consumer Internet space, any service that engenders a passionate and engaged following by users and creates a viral way for that service to grow -- that kind of growth is incredibly valuable," Pishevar said.
The VC said that photo-sharing and photo-tagging were the original growth drivers for Facebook.
"This space is so important to the future of what Facebook cares about, that paying 1% of your company value to bring in a team like this and make it a part of your future while taking that option away from competitors -- that's brilliant," Pishevar said.
Whether or not Facebook will wring more than $1 billion in value in the long-run from Instagram might never be clear, but right now the biggest winner, dollarwise at least, is Instagram CEO and founder Kevin Systrom. At 28, he reportedly owns 45% of the San Francisco-based company -- the largest stake -- that will be worth a cool $450 million once the deal closes.
The investors who backed Instagram obviously notched big wins, too. The company received a $7 million Series A round in February 2011 from Benchmark Capital and Twitter Inc. co-founder Jack Dorsey, Chris Sacca and Adam D'Angelo, a former Facebook chief technology officer.
Benchmark partner Matt Cohler sits on Instagram's board and also was an early employee at Facebook; he declined to comment. Baseline Ventures and Andreessen Horowitz provided Systrom with seed capital for Burbn, a predecessor company that in startup parlance, "pivoted" into Instagram.
Then there was the $50 million round that the company reportedly closed just last week; it is said to have valued Instagram at $500 million. Sequoia Capital reportedly led the round, with Thrive Capital and Benchmark participating.
Details were sketchy regarding how much each VC firm would make on the Facebook acquisition; more information could become available if Facebook updates its prospectus ahead of its IPO, which is widely expected to launch next month.