With Instagram Deal, Facebook Shows Its Worth

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To win over Instagram, Facebook was forced to show its hand.

In early April, Facebook bought the photo-sharing service for $1 billion, agreeing to pay roughly 30 percent in cash and 70 percent in stock, according to people briefed on the negotiations. At that level, Facebook is pegging its own stock price at roughly $30 a share. Based on those numbers, the giant social network is valued at north of $75 billion.

But Facebook could actually be worth more.

During the negotiations with Instagram, the parties framed the deal around a logical assumption: Facebook could soon trade publicly at a much higher market value. As part of the talks, the companies discussed a potential value of about $104 billion for Facebook, the people briefed on the negotiations said. Instagram’s co-founder Kevin Systrom first broached the number, one of the people said.

At $104 billion, the value is roughly in line with where the company has traded at times on the secondary market, where shares of the privately held company have been selling for as high as $40.

While Facebook executives didn’t promote the higher value, the figure helped the Instagram team assess the deal. When Facebook goes public, Instagram’s chief executive and investors could yield some extra profit on the shares of the social networking company. The reverse is true if Facebook doesn’t fare well in its initial public offering.

Previous Internet deals may give Instagram shareholders some cause for optimism. Amazon.com , for instance, bought Zappos in 2009. Amazon gave the shareholders of the shoe retailer 10 million shares, worth $807 million, plus some cash and additional restricted stock units. Those 10 million shares are now worth $1.9 billion.

While deal talks won’t dictate Facebook’s eventual price in the market, the acquisition could offer some insight on how the management team may be valuing the social network ahead of its highly anticipated I.P.O. The company, which is currently in the process of making final changes to its prospectus, is expected to go public next month, people with knowledge of the matter have said. The price of the offering will be determined by several factors, like market demand and the volatility in the equity markets.

With the Instagram deal, Mark Zuckerberg, 27, is also acknowledging the enormous value he has created in the eight years since starting the company.

Founded in his Harvard dormitory in 2004, Facebook has became the world’s largest social network, with more than 845 million users and some 250 million photographs uploaded each day. While it was not the first social Internet company, it has quickly become the largest. At $104 billion, Facebook is worth more than LinkedIn, Twitter, Groupon and Zynga combined. In 2011, Facebook booked a profit of $1 billion on $3.7 billion in revenue.

The Instagram deal, which was described as an “important milestone” by Mr. Zuckerberg, underscores how important mobile has become to Facebook’s ambitions.

With Instagram’s star rising, Mr. Zuckerberg moved quickly on the deal. On April 5, Instagram closed an investment round that valued it $500 million with a group of venture capital investors, including Sequoia Capital, Thrive Capital and Greylock Capital. The next day, Mr. Zuckerberg and Mr. Systrom, Instagram’s co-founder and chief executive, talked about the outlines of a deal. After a hectic weekend of discussions, the deal was finished on Sunday, and Mr. Zuckerberg unveiled $1 billion transaction the next day his Facebook profile page.

“We don’t plan on doing many more of these, if any at all,” Mr. Zuckerberg said, referring to big acquisitions. “But providing the best photo sharing experience is one reason why so many people love Facebook and we knew it would be worth bringing these two companies together.”