With Facebook's stock decline, the people who sold Instagram have also lost a considerable amount of their company's value because of poor negotiating tactics described by DealBook's Steven M. Davidoff. Reading the report, we're not sure Instagram acted so foolishly, though. Yes, Instagram has taken a hit with its current set-up. The famous $1 billion deal has lost almost $300 million with Facebook's stock hovering around $20 per share. And perhaps, Instagram, could have avoided this situation if they had "cut a better deal," as Davidoff explains. But, looking back to the details of the deal, Instagram didn't have much of a choice.
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When the deal went down Instagram negotiated $300 million in cash plus 23 million shares of Facebook stock, which at the time amounted to a $1 billion deal. That share-heavy set-up, however, isn't standard, or smart, according to Davidoff. "What is notable is that Instagram and Facebook did not agree to a floating share exchange ratio or a stock collar, two fairly common merger tools," he writes. "In contrast, Instagram agreed to a fixed number of shares rather than a fixed dollar value. That meant Instagram’s owners took the risk of a decline in Facebook shares in exchange for all the benefits of an increase." And so far it has proven a big risk, with the big hits Facebook's stock has taken these days. The lesson, argues Davidoff: Don't negotiate too "hastily." The deal went down in just three days, according to The Wall Street Journal's Shayndi Raice, Spencer Ante, and Emily Glazer, who had a detailed look at the back and forth between Mark Zuckerbeg and former Instagram honcho Kevin Systrom.
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But, when Instagram offered itself up to Facebook, at the time, their negotiating tactics didn't look so stupid. Here's how it went down, from Raice, Ante, and Glazer back in April:
Mr. Systrom found himself in Mr. Zuckerberg's house asking $2 billion for Instagram. Mr. Zuckerberg suggested looking at the value of Instagram as a percentage of the value of Facebook, people familiar with the matter said.
Mr. Zuckerberg, who planned to pay for Instagram mostly with stock, asked Mr. Systrom what he thought Facebook would be worth, the people said. If he believed Facebook would one day be worth as much as a company like Google at $200 billion or more, then the equivalent of 1% of Facebook would be sufficient to meet his price, Mr. Zuckerberg told Mr. Systrom, the people said.
It was as good an argument as any, considering that traditional ways of valuing a company—by its cash flow, or the sum of its parts—are ineffective when that company makes only one product and gives it away free.
$1 billion was already a ton of money for a company that made zero profit. The only way Zuckerberg would agree to that unreasonable request was to link its worth to Facebook's own value. In comparison to the $1 billion Instagram had, it has lost a big chunk of money. But, let us not forget that $738 million is a lot of money for a photo app company with 13 employees. Even if Facebook's stock sinks to $0, these guys still get $300 million—which is a lot more than they have paid for other start-ups. (Facebook paid a relatively paltry $80 million for Karma, its second biggest acquisition after Instagram.)
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Plus, things could still look up for Instagram. When the deal went down, the two CEOs based their negotiations on some future where Facebook would "one day be worth as much as a company like Google at $200 billion or more." It's been less than six months. Who knows? That day could still come.
