Instagram, an online photo-video sharing social media business was acquired by Facebook in April 2012 for $1 b in both cash and stock. Now it is being valued at $35 b. That is 35 times payoff in 2 years.
Was the buy a bargain (sellers that foolish, and buyers that smart), or is this just another of analyst's fantasies?
With social media companies one cannot tell as the euphoria that was there during the late 1990s regarding information technology companies seems to be rubbing off regarding the social media companies now. Human behavior is the same at all times. Greed and Fear are the easy masks people like to wear.
I am not saying that Instagram is not worth $35 b; what I would like to ask is how do we know? It could be worth any value. There isn't any rational basis at the moment to justify with confidence that it is worth something.
We haven't got the revenues and margins; we don't know the growth rate; we haven't got the reinvestment that is required to sustain the level of growth that is expected.
We can definitely have a set of assumptions about these, and come up with a value. However, I can guarantee that the intrinsic value of Instagram as a business would be anything, but that value. The reason is simple: with technology businesses, it is almost impossible predict the future course. We might want to see a level of growth, but to achieve that growth, reinvestment of capital is required; information about market size and market share is required; we should know the sustainable margins which leads us to understand the market and predict competition.
One way to go around this is to have a distribution of assumptions and come up with probabilities, and then the expected value. Heck, it doesn't work that way. There could be probabilities, but then, in reality the actual value is not based on probability, but on a single set of fundamentals. Which of these assumptions will hold true, you never know. We can use probabilities only when there is a very high probability of an event occurring. Rest is pure academic.
Isn't then valuing a technology business a futile exercise? What is the point in valuing a business just for the sake of it? We should be able to make a buy or sell decision based on our valuation. If we are not able to do that, I find the exercise only academic. Not too bad for a class of students, though.
Hypothetically, if Instagram is worth $35 b, it is a better business than say, Hershey ($23 b), Sony ($22 b), ICICI bank ($33 b), Kellogg's ($23 b), State Street ($33 b), Southwest Airlines ($27 b), and Cognizant ($32 b). Is that so? I don't know. I am not saying that these market values reflect their actual worth. At least these firms have established revenue models.
Instagram does not have meaningful revenues at the moment. It might have a revenue model, but we are not privy to that information. I would argue that even the managers would be wrong in their estimates for a start-up business like this one.
Instagram's value could even be higher than $35 b. What I mean is that at this moment we cannot know this for sure.
With all this behind, I might as well give my estimates of Instagram.
If Facebook is worth $222 b and has 1.35 b users, we can use this information to price (not value) Instagram.
Here we go, Instagram is worth $49 b.
We can use price-to-sales ratio of Facebook to price Instagram to $53 b.
I can use a set of assumptions on revenues, operating margins, growth rate, reinvestment rate, return on capital, and use that to estimate the value of Instagram. But, I will keep that for another time.
I have had fun with these exercises in the past (TCS/Infosys, Facebook, Twitter, Twitter, Nokia, TCS, Blackberry, Google, FB/WhatsApp, TCS, Apple), but have never used that for any investing decisions. In fact, my concluding thoughts have been similar; we cannot value technology businesses accurately.
Yet, who stops us from having some fun? Let's play along...
I am not saying that Instagram is not worth $35 b; what I would like to ask is how do we know? It could be worth any value. There isn't any rational basis at the moment to justify with confidence that it is worth something.
We haven't got the revenues and margins; we don't know the growth rate; we haven't got the reinvestment that is required to sustain the level of growth that is expected.
We can definitely have a set of assumptions about these, and come up with a value. However, I can guarantee that the intrinsic value of Instagram as a business would be anything, but that value. The reason is simple: with technology businesses, it is almost impossible predict the future course. We might want to see a level of growth, but to achieve that growth, reinvestment of capital is required; information about market size and market share is required; we should know the sustainable margins which leads us to understand the market and predict competition.
One way to go around this is to have a distribution of assumptions and come up with probabilities, and then the expected value. Heck, it doesn't work that way. There could be probabilities, but then, in reality the actual value is not based on probability, but on a single set of fundamentals. Which of these assumptions will hold true, you never know. We can use probabilities only when there is a very high probability of an event occurring. Rest is pure academic.
Isn't then valuing a technology business a futile exercise? What is the point in valuing a business just for the sake of it? We should be able to make a buy or sell decision based on our valuation. If we are not able to do that, I find the exercise only academic. Not too bad for a class of students, though.
Hypothetically, if Instagram is worth $35 b, it is a better business than say, Hershey ($23 b), Sony ($22 b), ICICI bank ($33 b), Kellogg's ($23 b), State Street ($33 b), Southwest Airlines ($27 b), and Cognizant ($32 b). Is that so? I don't know. I am not saying that these market values reflect their actual worth. At least these firms have established revenue models.
Instagram does not have meaningful revenues at the moment. It might have a revenue model, but we are not privy to that information. I would argue that even the managers would be wrong in their estimates for a start-up business like this one.
Instagram's value could even be higher than $35 b. What I mean is that at this moment we cannot know this for sure.
With all this behind, I might as well give my estimates of Instagram.
If Facebook is worth $222 b and has 1.35 b users, we can use this information to price (not value) Instagram.
Here we go, Instagram is worth $49 b.
We can use price-to-sales ratio of Facebook to price Instagram to $53 b.
I have had fun with these exercises in the past (TCS/Infosys, Facebook, Twitter, Twitter, Nokia, TCS, Blackberry, Google, FB/WhatsApp, TCS, Apple), but have never used that for any investing decisions. In fact, my concluding thoughts have been similar; we cannot value technology businesses accurately.
Yet, who stops us from having some fun? Let's play along...
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