When Facebook (NASDAQ:FB) purchased Instagram for $715 million last year, the price raised eyebrows; $715 million for a zero-revenue business? Sure, Facebook would eventually monetize the service, but no one knew when.
Now, The Wall Street Journal reports that Facebook will be selling ads on the platform within the next year. Will Facebook get its money's worth out of the acquisition, after all?
A tough job
Instagram's director of business operations, Emily White, has a tough job. She's "charged with turning a billion-dollar acquisition that has never made a cent into a real business," explained The Wall Street Journal author Evelyn Rusly. Though she's certainly backed by an experienced team at Facebook, $715 million is a lofty number looming over the business. Even more, she'll need to balance the fragile relationship between ads and experience. Can she do it? Can Instagram successfully monetize the photo-sharing app?
There's certainly potential. I recently estimated that Instagram could contribute as much as $1.2 billion in annual ad revenue if the photo-sharing app launched ad products by the second half of next year. But would ads frustrate Instagram's loyal user base?
"Theoretically, [Instagram] could be making hundreds of millions of dollars today, but they would need a big sales force and they would risk polluting the environment," Pivotal Research Group analyst Brian Wieser told the Journal.
Wieser has a good point. But Facebook has quite a bit of experience in this arena. Given Facebook's enormous success at monetizing mobile in the News Feed, Instagram has a good chance at pulling it off.
An untapped (expensive) goldmine
Instagram is still growing rapidly. The photo-sharing app has added 20 million monthly active users in less than three months -- growing monthly active users from 130 million to 150 million. With that kind of growth, no wonder Facebook is planning to monetize the service.
But living up to Instagram's valuation will be tough. While the actual purchase amount at the date of closing was $715 million, much of that was in Facebook stock. And the purchase took place when Facebook shares were trading near their all-time low. This means that the company lost out on massive share appreciation. Only 300 million of the deal was in cash. The rest was in vested and unvested Class B stock, 12-million and 11-million shares, respectively. If you do the math, vested shares were granted at approximately $18.42, and the unvested shares granted at about $17.64. With shares trading around $45 today, the acquisition has theoretically cost them closer to $1.5 billion than to the often-headlined price of $1 billion.
Keep an eye on Instagram
Given Instagram's massive potential as a contributor to the bottom line, it's good news to hear that Facebook is attempting to get some money out of its expensive acquisition. As Instagram begins to implement an advertising strategy, Facebook investors should keep an eye on the app's progress.
If Instagram can contribute $1.2 billion to the bottom line through ads every year, that would boost Facebook's trailing-12-month revenue by a nice 20%.
What do you think? Is it possible to successfully monetize Instagram?
Fool contributor Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.