Why Facebook bought Instagram on the way to its $100-billion IPO

Not since Google bought YouTube has an acquisition grabbed the world’s attention the way Facebook’s $1-billion deal to buy Instagram. And it’s bound to get tongues wagging again about startup valuations shooting into the stratosphere.

“It’s unprecedented on almost any metric you look at,” said Paul Kedrosky, a senior fellow at the Kauffman Foundation.

The San Francisco startup has just 13 employees. That works out to be $76 million per employee, Kedrosky pointed out.

At the same time, Instagram had no business model, no revenue. “That’s going to make some people’s eyes roll back in their heads and connect to their ears,” Kedrosky said.

So why did Facebook pay so much for a photo-sharing app? As we’ve written in the past, Instagram was not just a photo-sharing app. Sure it made photo sharing applications for smartphones that allow users to take photos and jazz them with retro filters. But it was becoming a very powerful mobile social network that let you share the photos with friends on Instagram or on other social networks

So Instagram may not have given Facebook a run for its money, but it was sure giving Facebook a run for its popularity, and on the most important platform of all: mobile.

“It was not just a photo-sharing app. It was a way that people were communicating with each other the same way they might have on Facebook,” Kedrosky said. “Facebook saw it as a fast-growing competitor.”

Its Android app was adding 1 million users a day, its IOS app 25 million.

“It was becoming a competitive social platform,” Kedrosky said.

Which is why Facebook did the deal in the midst of its federally required quiet period, mucking up what had so far been a very orderly and neat march toward a $100-billion initial public stock offering.

“In many ways, Facebook would rather not have done this. It creates a mess for them with having to issue an amended S-1 with this highly material transaction,” Kedrosky said. “What that tells you is that Facebook felt like it had to do the deal.”

Instagram had just raised a new round of funding that valued the app maker at $500 million. Other Facebook competitors were also circling, raising the possibility of a bidding war.

“Getting it done beats losing Instagram to a competitor,” Kedrosky said.

And that makes the price and the timing worth it.

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