A New Tech Bubble

In the last hour I heard that Facebook has bought Instagram for $1billion dollars. This is literally double the valuation that was set for Instagram by VC investors at the end of last week, who put in $50 million at a valuation of $500million!

At the last count, Instagram had 30 million users. It recently launched an Android version of their application, so lets be optimistic and say they’ve already doubled their user base to 60 million.

What is Instagram? It is a smartphone application which lets users add some special effects to photos and share them with some text on the various social networks. Lets be clear, Instagram has 13 employees and had 100,000 users less than 2 years ago. Their growth is impressive, but I am not aware that the company has any revenue streams! Their $1billion valuation is based entirely on perceived potential value and the assumption that next week someone else won’t release something far better or make them utterly redundant.

I’ve also been debating with myself over the valuation of Facebook for some time, given they will IPO this summer for circa $100 billion. I guess it makes sense for a company valued at 100 times last year’s profits to pay a crazy amount for a startup, but haven’t we been here before?

Valuing companies based on their idea, user figures and growth rates is a dangerous game. It didn’t work out well for MySpace, or people like ICQ which many people won’t have even heard of. ICQ was once the biggest instant messaging platform on the Internet, bigger than even AOL .. which is another “multi-billion dollar” company that has fallen from grace given the constantly disruptive nature of the Internet. These companies, and many more, simply failed to build ‘moats’ around them to protect themselves from competition … their only advantage was their user base. However, we live in a worth where users are more mobile than ever before.

Getting users didn’t help AOL, MySpace, ICQ … to name but a few. It is MONEY that businesses need to generate, as well as cement a genuine competitive advantage. With $1 billion, how easily could you create a smartphone app and get 50 million users? That’s the test people should ask themselves … could I compete and beat the company I am buying if I decided to use the money to set-up in competition? How likely is it that trends/fashion will change? Will technology move on so quickly that some 20-year old could write something that kills me before I can react?

We are now so integrated, so advanced technically that a new smartphone game (Draw Something) can reach 1 million users in just 9 days (it took Facebook ~9 months). By the time you hear about a competitor and it is in the app stores, it is probably too late!

Facebook probably bought Instagram to avoid any distractions from its IPO … and I doubt it paid cash, which is another reason for a very high valuation (if you’re getting paid in over-priced stock, you’d want a lot more of it than cash). However it is sending a dangerous message out to Silicon Valley, VCs and startups … that a smartphone application which anyone could duplicate and improve upon for less than $1 million & with no revenues could become worth $1 billion if you get enough users & brand awareness.

I’d say we’re back in bubble territory … some of these companies could see the biggest falls from grace ever witnessed.

I fear for Instagram, which Apple or Samsung could kill in a heartbeat by adding similar image filters & functionality directly in their default camera apps.

I also fear for Facebook, their actions look desperate.

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