Facebook’s blockbuster purchase of photo sharing site Instagram has sparked an important debate about whether we are witnessing the next stage of a steadily inflating tech bubble that will pop sooner or later.
On one side we have those who are pointing out that a billion dollars for a business with barely any revenue and 13 employees is clear evidence of a bubble while those on the other side say its a strategic purchase that is only one per cent of Facebook’s estimated $US100 billion market value.
In think the latter argument is deeply flawed, comparing the purchase price against the value of other assets is always risky – particularly in a market where those underlying assets are being valued at the same inflated rates.
We could think of it in terms of a Dutch farmer in early 1637 claiming that paying a thousand Florins for a tulip is fine when he has a warehouse containing hundreds of them.
In reality, that farmer during the Dutch Tulip mania of the 17th Century held contracts for delivery; just as modern day investors held collateral debt obligations (CDOs).
Measuring value against other inflated assets is always dangerous and only fuels a bubble.
A much more concerning way of judging the wisdom of Facebook’s investment is against profit and revenue.
If we compare the purchase of Instagram against Facebook’s revenue, then the investment has cost them three months income.
Should we compare the acquisition against profit, Instagram has cost Facebook five years of profit at current rates.
Both of those numbers are very high and it indicates how big a gamble the Instagram acquisition is for Facebook.
It can be argued there is a lot of blue sky ahead for Facebook and that future profits and revenues will justify the Instagram purchase.
There’s also a very compelling argument that Facebook has to get into mobile services and Instagram does that.
Whether Instagram is worth three months income or five years profit to Facebook remains to be seen, but we should have no doubt it indicates we are well into Tech Boom 2.0.
Paul Wallbank is a business technology writer, broadcaster and blogger and author of eBusiness: Seven Steps to Online Success. Read more of Paul's thoughts here.