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Using Barney, J. (2002). Gaining and Sustaining CompetitiveAdvantage. New Jersey: Prentice Hall as textbook.

What is your opinion concerning this article bases onMergers and acquisitions, International Strategies.

Facebook, Instagram and the Disciplines of Mergers andAcquisitions

By Robert Teitelman

For years, it’s been a popular pastime to decry the use ofmergers and acquisitions (M&A) as a colossal, ego-inflating,comp-expanding, waste-of-shareholder-money exercise. Most of thesecharges are either wildly exaggerated or absurdly simplistic.M&A is a necessary means for companies to grow, particularly ina world so driven by change. Failures are unavoidable — it’s noteasy — although measuring what’s exactly a failure or a successgiven the complexities of large corporations is pretty difficult.But it’s very true that in overheating markets, when currency inthe form of shares is highly inflated, lots of lousy,value-destroying deals can get hatched. This is particularly thecase in intensely competitive technology industries, where thevalue creation of a given deal may lie not in the currentorganization but in a technique, a process, a piece of intellectualproperty still undergoing gestation: that is, in an opaque future.Thus the truism beloved of Warren Buffett: In M&A, there’snothing riskier than tech deals.

And then there’s Facebook and Instagram. Facebook is famouslypaying a cool billion dollars for the two-year-old app-based photoservice. Instagram has 13 employees, 30 million users and norevenues. Facebook’s Mark Zuckerberg decided the social media giantabsolutely had to have the startup, and took a year’s worth of cashflow and offered it up, about twice Instagram’s recently closedSeries B venture round valuing the company at $500 million. Therewas no indication of other bidders, though everyone seems convincedthat a Google or an Apple was lurking out there ready to make itsown pre-emptive bid. In the developing meme about the Instagramdeal, Zuckerberg didn’t have a choice: He had to strike. It was eator be eaten. The sheer uncertainty of the social media landscapecan’t tolerate hesitation; it demanded action. In California,venture capitalists, investment bankers and analysts can’t praisethe deal highly enough (of course, they all profit from theresulting euphoria). Zuckerberg showed brilliance, they said, byrecognizing Instagram’s potential and making the bid — despite thefact that this will further complicate Facebook’s enormous andmuch-hyped IPO in a month or so.

That alone should cause one to pause along with the profoundfaith in a young CEO who hasn’t done much dealmaking. The issuehere is not that Zuckerberg made a good decision or not. We’ll findout in time whether Instagram is a PayPal or a Skype (both eBayacquisitions: the former, as The New York Times lays outtoday, a big success, the latter, a big loser) or a Flickr (aYahoo! bomb) or a Flip (which Cisco, a regular and expert user ofM&A, shut down last year). Instagram most closely resemblessome of the giant telecom deals from before the bubble burst in2001, particularly in the size of the deal and the tiny number ofemployees. Billions of dollars in those deals were written off whenthe market collapsed. And let us not wallow in AOL-Time Warneragain.

No, the issue with these sorts of deals is how any investor canmake a rational judgment about a) whether this deal makes strategicsense, or b) whether the price makes any sense at all. The two arerelated, of course. The view from Silicon Valley seems to be thatFacebook had the money so why not spend it. Cutting-edge techcompanies need to bet big and make “strategic deals,” that is,deals that can’t be be valued — the feeling is that Zuckerberg is agenius and if he doesn’t know what Facebook needs, then nobodydoes. Facebook isn’t even public so Zuckerberg can spend his moneyany way he wants and the reaction of users and the tech communityseems to be so positive it can’t go wrong. Well, of course, it cango wrong. Crowds change their minds, and Instagram’s users in theTwittersphere don’t seem to want to be enveloped into Facebookworld, though this is about as scientific as a finger in thebreeze. Apps (and social media sites) come and go. Instagram hasvery few employees, all of whom are now loaded with dough. They maystay and develop the product — though no one seems to know howit’ll make money — or they may drift off to start new companies orgo into politics or try venture capital. There seems to be fewbarriers to entry in the app world, and it’s hard to imagine thatInstagram, as nifty as it is, is unassailable. Moreover, it’sunclear whether Instagram boasts the kind of network effects thatmakes PayPal, YouTube, Google, Microsoft, Apple and Facebook soformidable. Remarkably, few seem to be asking.

Again, this could turn out to be a fabulous deal. But this isthe kind of deal that gives M&A a bad name. The notion thatZuckerberg can spend “his” money any way he wants is not only wrong— it’s not really his — but about to become a real problem whenpublic investors buy shares. (Substitute, say, Bank of America forFacebook and see how that works.) A billion dollars remains a bignumber, no matter the market cap. Moreover, it’s pretty clear, asthe Financial Times‘ Lex column pointed out Tuesday, thatdespite Zuckerberg’s statement that this is a one-off deal, what itreally suggests — and that the tech crowd confirms in its comments— is that there could well be other Instagrams to be scooped up.Facebook is implicitly admitting that in a burgeoning andremarkably fluid app world, it can’t really go it alone: It needsto buy and buy and buy. Again, that’s not a shock (Google has beena busy buyer) — though Zuckerberg, prepping for public companystatus, should be more careful with statements about one-offs hemay have to take back, and that will hurt him with investors oncehe goes public.

Will this deal hurt Facebook if it never works out? Not really.It’s just a write-off, which Facebook can shrug off. By then therewill be new hot apps, racking up millions of grazing users. Butwhat this deal tells us most clearly is just how risky the Facebookenterprise is. For Zuckerberg to make a pre-emptive bid that’stwice the venture valuation from two weeks ago — and one a monthbefore a public offering — suggests two things: either he’sundisciplined with all that money (were there negotiations or duediligence? what’s the breakdown of cash and shares?) or that thepowerful network effects that keep users coming back to Facebookmay not be as strong as a relatively obscure two-year-old startup’sapp.

Is this a sign of a bubble? I don’t believe that, unless youdefine bubble in a very narrow sense. Social media is clearlyheating up, but for rational reasons: new devices, new services,new apps, an exploding audience. Instagram might look like an olddot-com — lots of users that may come or go, no viable revenuemodel — but Facebook does not: Like Google, it has found a way tomake a lot of money. But you don’t have to have a full-blown bubbleto lose your discipline as a buyer. You just need the suddenappearance of a lot of cash. Which is how M&A gets a badname.