The success of Instagram after its $1bn purchase shows how difficult it is to call a bubble. But we should not expect a repeat of 2000 if there is a downturn
When Facebook paid $1bn (£658m) for Instagram, a popular but small photo-sharing service, in April 2012, the word everyone reached for was “bubble”.
In some ways, they were entitled to. At the time, Instagram had 13 employees and no plan to make any money. To the untrained eye, it was just one of just a number of interchangeable, faddy smartphone apps whose entire appeal lay in arty image filters that turned bad photos into mediocre ones.
The year before, Rupert Murdoch had offloaded Myspace for $35m – 6pc of what News Corp had paid for it – and Friends Reunited, another social network that had been obliterated by Facebook, had been valued at £5m seven years after ITV paid £120m for it.
Social media’s fickleness was thus at the forefront of many people’s minds, while the Nasdaq had surpassed 2007’s levels to trade at its highest point for 12 years.
Instagram’s sale, which valued the service at more than the market capitalisation of the New York Times, seemed like the harbinger of yet another period of dotcom hubris.
If Facebook’s purchase was the result of a bubble, though, it’s a bubble that’s been inflating for some time since. Last week, Instagram announced that some 400m people use it every month ; making it more than 10 times bigger than when Facebook bought the service.
Instagram only introduced advertising in 2013, but this year it will bring in around $600m in ad revenues, according to predictions from eMarketer.
Next year it will be $1.5bn and in 2017 $2.8bn – or around 14pc of Facebook’s total mobile advertising revenues. It has taken less than five years to reach 400m users, about a year less than Facebook and a milestone that nine-year-old Twitter will struggle to achieve based on current growth rates.
An analysis from Citigroup last year suggested that on a “conservative” valuation, Instagram was worth $35bn.
What the original deal’s critics didn’t see, but Facebook’s founder Mark Zuckerberg did, was the change in how people were spending their time online.
In 2012 most Brits didn’t own a smartphone, now more than two thirds do . As phone cameras and mobile internet connections have improved, photo sharing – something that people have loved since cameras became affordable – has exploded online.
Pundits may have been stunned at Instagram’s $1bn price tag in 2012, but now the deal is seen as a masterstroke, and the episode seems to be a very clear example of how problematic it is to call a bubble.
“Normal” valuation metrics are obsolete when trying to value something like Instagram; in three years’ time it could be the biggest thing in the world, or totally forgotten.
When Snapchat, another photo sharing app, reportedly turned down a $3bn offer from Facebook in 2013, it was widely mocked; now it would fetch several times that.
On the other hand, several investments have backfired immensely. Google paid $12.5bn for Motorola Mobility in 2011, anticipating a patent war that never really got going, and sold it to Lenovo for $3bn last year .
Oyster, an ebook subscription service that raised millions while attempting to replicate the success of Spotify and Netflix, shut down last week, as new figures showed ebook sales falling into decline just a few years after they purported to kill the paperback.
Cash is now being thrown at start-ups that have no revenue, let alone profits, at an unprecedented rate. More than 100 private tech companies are valued at more than $1bn, and more are being created than ever before, according to CB Insights .
Of course, there will be a downturn; there always is. But whether that will be this year, five years away or 10 years away is impossible to call.
One thing that we can predict about the bubble bursting is that it will be very different from 2000. At the peak of the dotcom boom, almost any company with a web address could go public with a valuation of millions. People quit their jobs and put their life savings into the markets. When the dam broke, livelihoods were ruined.
This time, most of the frothiness is in private capital. Stock market valuations, on the whole, are much more reasonable as a multiple of earnings than they were at the turn of the century, but the likes of Uber, flush with venture capital cash seeking a return, are breaking records for privately held company valuations.
Even these lofty amounts are somewhat illusory, based on investments made in convertible preference shares, rather than equity: When their investments go bankrupt, VCs will be paid back in company assets, rather than losing the cash.
The success of Instagram, which is beyond anyone’s expectations, shows why predicting a bubble popping is next to impossible. But when it does happen, those with the most to lose are the companies themselves. If this is a bubble, it’s very different from last time round.
This article was written by James Titcomb from The Daily Telegraph and was legally licensed through the NewsCred publisher network.