Apparently for Facebook FB +0.66%, $3 billion is the new $1 billion. With reports that the social-networking giant tried to buy upstart Snapchat for 3 times what it paid just last year for Instagram, it’s clear CEO Mark Zuckerberg believes that if you can’t beat them, buy them. But while most of the incredulous reactions to yesterday’s news about the proposed acquisition centered around Snapchat’s willingness to walk away from the deal, less was said about the fact that Facebook was ready to pay more than the market cap of the Cheesecake Factory for a 2-year-old app that until recently was best known for its use in sexting. Has Zuckerberg gone completely mad? On the contrary, his designs on Snapchat were borne of the same healthy dose of fear that led him to buy Instagram last year. Intel's INTC -0.79% Andy Grove famously said, “Only the paranoid survive” and Zuckerberg seems to be worried about every would-be claimant to his throne.
What Zuckerberg gets is that Facebook’s position at the apex of social networking is under constant attack. The power of Instagram was two-fold: It was strong in photos, where Facebook dominated, and in mobile, where Facebook was decidedly weak early in 2012. Had someone else — for example Twitter, the jilted suitor Facebook beat out — been able to woo Instagram, Facebook would have risked losing its control over photo sharing as well as an inroad into mobile. Critics will say that the Instagram acquisition has proved mixed. That despite the five-fold growth in users since Facebook’s takeover, so many other ways to share photos have developed that whatever strategic threat Facebook might have headed off, it didn’t achieve much other than buying Instagram for a bargain price. Those opinions are perhaps best encapsulated by the always-erudite Benedict Evans:
He wrote that a few days ago. We then learned of the Snapchat offer which seems to suggest that, while Facebook won’t be buying “the next ten,” it will try to buy at least a few of them. And quite frankly, there’s sound logic to that. Facebook can’t possibly hope to buy up all the barbarians at the gate. First of all, they aren’t all for sale. Even a Snapchat can turn down an offer that would make its two founders billionaires at 23 and 25 because a recent funding gives them some liquidity and strong capital markets have them believing there’s a higher price to be obtained next year. Second, the incredibly rapid growth of all these services, several of which has scaled past 100 million users far faster than Facebook itself did, proves that there are likely going to be more of them than it’s realistic for anyone to try to own all of.
But Facebook doesn’t need to acquire everyone, it just needs to be constantly buying someone that either protects its flank or offers a new opportunity. By Facebook’s very nature, the user base will get older with each passing year. (This is an inevitable consequence of being the default network and having rich social-graph data on more than a billion people.) As a result, the next wave of internet users, will likely see it as someone else’s app. While they might sign up, Facebook itself admits, they are likely to use the service somewhat less. Teens will always seeking the new. As Evans points out, the glue of your smartphone’s address book and notifications makes it increasingly easy to use several apps at the same time to communicate and in this paradigm, Facebook itself becomes just one of many.
But Facebook still wins so long as it controls some of the others apps on your home screen. However those end up making money — and most will likely do that with some form of advertising — Facebook’s relationship with more than a million advertisers gives it a leg up in profiting from a given app. And when the current investment climate is replaced by a more normal one, where the need for profits replaces the ability to exist endlessly on investors’ capital, Facebook-owned services will likely fare well. So Facebook is in a situation where it can benefit monetarily from these acquisitions as well as strategically. It keeps the next wave of users in the “Greater Facebook” family and it uses its increasing leverage as an advertising powerhouse to grow from the sub-$10 billion company is today to the $20+ billion behemoth it can become by mid-decade.
And as for resources, Facebook is flush. It has more than $9 billion in cash and marketable securities on its balance sheet. It also generated $3 billion in cash flow from operations in just the first three quarters of 2013. Buying a Snapchat would make not dent to its bank account. Keep in mind, also, the company is worth nearly $120 billion and could use stock as currency for future deals (though it offered cash to Snapchat). If you view these kinds of things as insurance against someone rising up to defeat you, it’s perfectly reasonable for Facebook to spend 5% or so of its value every year on acquiring “threats” that are clearly strategic fits to its business of connecting people. That amount would purchase two Snapchats this year and perhaps even more of them in 2014.
A significant premium will be placed on making the right bets. Facebook will need the skill of Google GOOG +0.44%, which has arguably the greatest acquisition track record in the history of Silicon Valley (YouTube, Android, Applied Semantics). And for the moment, at least, it no longer matters whether Snapchat was a good bet or not. But Zuckerberg tried to clone Snapchat’s features with Facebook’s own Poke app, only to see the competitor grow and the homegrown one fail. A long time back, eBay had a similar problem with its home-built payments system and had to go out and buy PayPal, which ended up as the most important piece of the company. Maybe chat and personal photo-sharing apps become the minnow that eats the whale of social and Snapchat wisely remained independent. Or maybe Facebook convinces the next one to join its family and crushes Snapchat. Zuckerberg is doubtless already trying to decide which one that is. And how much to pay.