When Facebook announced its Initial Public Offering earlier this year, we asked how a company with estimated profits of $335m to $1bn possibly attract a market valuation of $100bn?
Ahead of their flotation, during their SEC mandated ‘quiet period’, Facebook appears to have created a new question – how can a company with just 13 staff and no revenue justify a price tag of $1bn?
Facebook has bought the mobile photo sharing service Instagram for a shocking $1bn.
The business is less than two years old and has already attracted 30m users who upload more than 5m photos each day.
Only a week before selling to Facebook for $1bn, Instagram raised $50m of venture capital funding which valued the business at $500m.
How can such a tech business be worth so much? Even a $500m valuation point is difficult to swallow.
Comparisons have been made to Google buying YouTube for $1.6bn nearly six years ago. At the time, YouTube had no real revenue and very few staff.
Of course today YouTube has subsequently become one of the most popular websites on the Internet, generating substantial advertising revenue for both Google and those who upload videos.
But can Instagram deliver the same for Facebook as YouTube did for Google.
The cynic in me thinks Facebook is simply fueling a tech bubble with this acquisition. By spending $1bn on Instagram, they go some way to justifying the predicted price of their own flotation when it takes place.
There are good business reasons for the Instagram acquisition. As a regular user of both Instagram and Facebook, they serve different purposes and better integration between the two would be welcome.
I remain unconvinced that Facebook could have not simply developed their own photo capability within a smartphone app. The series of retro filters that Instagram users apply to their mobile phone snapshots are a nice feature, but hardly groundbreaking technology.
Whenever we see valuations like this that have little grounding in fundamental business principles, it is quite right for investors to question whether another bubble is about to burst.
We will be keeping a close eye on the tech sector for the rest of this year, adjusting our recommended allocations and funds accordingly should things appear to be overheating.
