Facebook-Instagram deal: Smart buy or bubble?

@CNNMoneyTech April 10, 2012: 6:11 PM ET

NEW YORK (CNNMoney) -- Holy Instagram!

The two-year old company agreed to sell itself to Facebook for $1 billion Monday, making it Facebook's biggest acquisition to date.

The deal immediately sparked a debate as to whether buying Instagram, which allows its roughly 30 million users to add distinctive filters to snapshots and share them with friends, was a bargain for Facebook or a sign that we're nearing the top for social media valuations.

Following the announcement, Twitter streams and blog posts were filled with all types of reactions, mainly honing in on the price tag.

"13 employees and no revenue = $1 billion. Brilliant," Justin Davey, head of business development at Contently, said.

Chris Dixon, who recently sold his company Hunch to eBay (EBAY, Fortune 500), tweeted, "How many "bubble" articles appeared after Google's acquisition of YouTube? Turns out it was one the best acquisitions of the decade."

Ashkan Karbasfroosha, CEO of Watchmojo, replied with what seems to be a general consensus following the Instagram momentum.

"To be fair @cdixon it could be BOTH a bubble and a smart deal," he replied.

Instagram does have momentum on its side. After the wildly popular service recently launched its Android app, the company signed on a million users in less than a day.

But does this justify the price tag of $1 billion? Or did Facebook just inflate the bubble?

Feelings are mixed. Todd Dagres, founder and general partner of Spark Capital and an investor in companies like Twitter and Tumblr, says context is everything.

"A 500 day old startup sells for $1 billion. It looks nuts," he says. "But if you look at it in terms of what it means to Facebook and in terms of what was Instagram accomplishing and where could it be a year form now, I don't think its crazy at all."

So what does the deal mean for Facebook? According to Steve Beck founder of cg42, a consulting firm focused on tech M&A, many of Instagram's strengths are Facebook's weaknesses.

"Instagram has a strong brand and a strong offering in a category where Facebook has had challenges," Beck said. "Specifically in terms of mobile and photos. You have to look at it through the lens of how valuable is the mobile experience and how valuable is the photo experience?"

Beck says the deal is an investment for the social network giant. Facebook's mobile applications have always been an Achilles heel for the company. The Facebook experience on smartphones has never been perceived as particularly seamless. It wasn't until recently that the company announced plans to try to monetize mobile ads.

It's no secret that Facebook was eager to acquire Instagram, which exploded on mobile devices. There had been a steady flow of Facebook acquisition rumors since Instagram was barely hatched.

And while the price tag is steep, Dagres defends it. "For Facebook to pay 1% of their potential market cap to acquire a company that's both a threat and could add another source of subscribers and revenue -- it's a no-brainer," he says.

Of course, that implies that Facebook will be able to go public at a $100 billion market cap. That may very well happen. But it's also legitimate to wonder if Facebook can sustain that valuation.

Whether or not Facebook's purchase of Instagram is evidence of an inflating bubble, it's most certainly a sign of the times. Hot apps go big or get bought. Often times going big quickly translates to getting bought. Most recently Zynga (ZNGA) scooped up OMGPop, the maker of hit game "Draw Something," just six weeks after the viral game launched.

Dagres says we'll see more acquisitions from Facebook, Google (GOOG, Fortune 500), and Microsoft (MSFT, Fortune 500), and even potentially Apple (AAPL, Fortune 500), which is not known for acquiring startups.

"These guys are all colliding, they're all trying to get the customer's attention, get the eyeballs, and engage the customer." he said. "I still think there's a ways to go here in this market. I don't think you're going to see this exuberance slow down that much."

But it's also clear that not all apps will thrive -- even if they have high profile backing.

The Instagram deal comes over a year after venture capital firms Sequoia Capital, Bain Capital, and Silicon Valley Bank infused $41 million in funding into Color, an app that promised to create a unique photo sharing experience. The investment ramped up the conversation, with people wondering, will this momentum last?

So far, the answer seems to be yes for Instagram. But not for Color. To top of page

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