Why are Facebook buying Instagram for $1bn?

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Mark Zuckerberg's Facebook buys Instagram
Facebook bought Instagram for $1 billion Photo: REUTERS/Robert Galbraith

Can Instagram, a company that has only been in business for 500 days, really be worth $1 billion?

In simple terms, if that is what someone, in this case, Facebook, is prepared to pay for it then yes.

But just last week venture capitalists in the United States valued the company at half that. So why is Facebook willing to splurge such a huge amount of money?

Facebook buys Instagram
Why are Facebook spending such a large amount of money on Instagram? Credit: Instagram

Well an undisclosed amount of the deal is understood to be in shares from a company, Facebook, that is yet to be sold on the stock market.

Facebook's potential value when it floats on the market, expected to be later this year, is potentially as much as 100 billion.

So let's look at it another way. One billion dollars may not sound like a realistic price for a company with just 13 staff and no revenue, (yes you read that correctly, NO revenue).

But could Instagram, which is growing at a cracking pace, be worth 1% of Facebook? Quite possibly yes.

And in truth, with Facebook yet to be floated, so its value unknown, this is a deal that swaps a lot of paper for another bunch of paper.

Even so, why would the online titan Facebook want to buy Instagram in any case? Just last week the app company, which in case, like many of us you're not familiar with it, is an app that is used for photo sharing, launched its new version for Android - Google's phone.

More than a million people downloaded it on the first day that it was available. That is an extraordinary take up rate for any product.

Enormous and dominant as it is, Facebook's success has predominantly been based on the desktop, with its use on mobiles growing alongside.

Instagram is a hugely successful mobile technology product that gives Facebook a rapidly growing slice of that fast growing sector.

And they are not the only ones. Recently, what was a small games developer OMGPOP, who created the app Draw Something, a bit like mobile pictionary, was bought by Zynga, the developer for $180 million.

That was OMGPOP's reward after it reportedly got 50 million downloads in just 50 days!

With the cost of developing such a product collapsing and the routes to market multiplying small companies with a good idea can catch the eye of those with big cheque books much more easily than in times go by.

But with the recent past littered with technology acquisitions that have subsequently gone awry - Bebo, My Space, and even Friends Reunited, the billion dollar price tag for Instagram could over time prove to be misguided.

Facebook's Mark Zuckerberg
Mark Zuckerberg can afford to make the odd mistake Credit: AP Photo/Paul Sakuma

But with Facebook itself warming up to what could be the biggest business float of all time, even if the deal does not work out, Mark Zuckerberg and his colleagues can certainly afford to make the odd mistake.