The Breakdown

Explaining Southern California's economy

How the Facebook-Instagram deal shakes out

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27302 full

Facebook "reported" quarterly financials today, as part of the prelude to its IPO in May. Through a required filing with the SEC, we learned that it's costing a lot more to be Facebook, as profits dropped 12 percent, to $205 million from $233 million. We also learned how the Instagram deal is getting done. This is from the LATimes:

The regulatory filing also disclosed details of Facebook's agreement to buy Instagram. The company paid for the $1-billion deal with $300 million in cash and 23 million shares. Facebook placed a value of $30.89 apiece on its shares as of Jan. 31. Facebook said it would pay Instagram $200 million in cash if the government blocked the $1-billion deal.

So only 30 percent of the deal is in cash, which still isn't too bad for a company — Instagram — that didn't exist two years ago and has no revenues and no real business model (besides being sold to Facebook for $1 billion after it ate Facebook's lunch for a year in mobile photo uploading and sharing). 

Right now, Facebook is spending money at a pretty serious clip. That's $300 million to Instagram and $550 million to Microsoft, to pick up a trove of former AOL patents. It's going to need some serious growth post-IPO to support this kind of spending, if it continues (and it will probably have to, as Facebook can't solve all its problems on its own). 

Nearing 1 billion users on the Web, Facebook will need to exploit the greater growth potential in mobile, where it has around half that number and no real revenues yet. But therein lies the problem. Facebook is rapidly being outpaced by the surge in mobile. This is, after all, a company that has its DNA in the desktop/laptop web. Instagram didn't really even have a website. 

So what will Facebook do to capture this growth? "There will be many more Instgrams," as the Financial Times recently put it. You can easily see Facebook using its IPO bounty and ongoing ability to issue more stock against a potential $100-billion market cap as a way to buy every little appmaker that figures out a way to do something Facebook can't. That will be the game in Silicon Valley moving forward: to devise and fund something that exploits a Facebook weakness, becomes wildly popular off the free labors of millions, then exit by...selling yourself to Facebook! 

Will Mark Zuckerberg be happy presiding over the largest holding company the online world has ever known? Maybe. But then again, he won't have to manage the unwieldy beast himself. That said, the era of innovation at Facebook may be drawing to close.

Follow Matthew DeBord and the DeBord Report on Twitter.

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