Silicon Valley Is Swimming in Cash, and That's a Problem

After years of business success, Silicon Valley is flush with cash -- and it's becoming a problem.

Usually, having plentiful cash is a good thing for a company. The money can act as a cushion in bad times, be returned to shareholders in dividends or buybacks, or used to acquire other companies. But in Silicon Valley, a rash of recent acquisitions should have investors concerned.

A trip down memory lane
The track record for acquisitions in Silicon Valley is less than stellar. Even managers who operate successful businesses have a hard time spotting good up-and-coming businesses. And the multiples that are generally paid in the tech sector leave little room for error.

Remember Hewlett-Packard's (NYSE: HPQ  ) acquisitions of Compaq and Palm? The Compaq deal cost HP $25 billion in stock, diluting existing shareholders. What did HP shareholders get in return? A business that management considered jettisoning last year.

The Palm deal was smaller, but it came with even less reward. HP was trying to get a foothold in the smartphone and tablet software business with the purchase of Palm, but it has been greatly overshadowed by Google's homegrown Android platform. A little over a year after Palm was acquired, HP wrote down $3.3 billion worth of assets, half of which was related to shutting down its webOS business.

Two years after acquiring Flip Video camera maker Pure Digital Technologies, Cisco Systems (Nasdaq: CSCO  ) wrote down over half of the $590 million purchase price. Flip cameras were cool for a minute, but that wasn't a fad that was going to last long.

eBay has had an adventure with Skype that could be considered a success or a failure. It had to take a $1.4 billion writedown not long after its original $2.6 billion investment in Skype. Then, after selling a 70% stake in Skype for a small profit to a group of investors, eBay missed out on most of the profit when Skype was sold to Microsoft (Nasdaq: MSFT  ) for $8.5 billion. This deal ended up being profitable for eBay, but the auctioneer's execution was far from flawless.

The track record of Silicon Valley executives making big acquisitions is anything but impressive, and the trend may continue.

Recent deals don't change the trend
Cisco recently announced it was spending $5 billion to buy video software maker NDS Group. The company paid about 20 times earnings for the enterprise, a reasonable price when you consider some of the other tech deals that have gone awry. But Motley Fool tech analyst Eric Bleeker thinks this is just another dumb buy.

Which brings me north of Silicon Valley to Amazon's announcement yesterday that it is buying Kiva Systems, a robot maker, for $775 million. I understand that fulfillment centers are at the center of Amazon's business, but I'm having a hard time seeing how Amazon is going to make money on this deal. Is it going to get into the robot-selling business, or is this a $775 million acquisition just for internal capabilities, something it could have added by simply buying robots? I'm at a loss.

Another cash-rich company, Intel (Nasdaq: INTC  ) , bought McAfee, a maker of security software, for $7.68 billion in 2011. That price valued McAfee at nearly four times sales. More importantly, security software was a long reach from the company's chip-making core and had a number of analysts scratching their heads over the move.

These three recent deals won't necessarily fail or be poor investments. They may be wild successes. But they show that when companies like Intel, Cisco, Microsoft, and others have too much cash, they get restless. When they get restless, they make a splashy move with shareholder money. History has shown that these kinds of moves don't pay off.

Too much cash is the problem
A company with too much cash is like a kid with too much time on his hands or a college student with a limitless credit card. There's bound to be trouble.

When managers aren't busy buying back stock to pump up their own stock option values, they're empire-building by buying companies. Not a lot of companies -- outside of that famous one in Omaha -- have a strong record of creating value with acquisitions, especially in Silicon Valley. They would probably be better off paying even larger dividends than buying companies or their own shares, as fellow Fool Morgan Housel argues.

If there's one thing Apple (Nasdaq: AAPL  ) has done right, it's avoiding outlandish acquisitions and building a business mostly from within. Maybe this is the model the rest of Silicon Valley could learn from.

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Fool contributor Travis Hoium manages an account that owns shares of Intel and Microsoft. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

The Motley Fool owns shares of Google, Cisco Systems, Apple, Microsoft, Amazon.com, and Intel. Motley Fool newsletter services have recommended buying shares of Amazon.com, Microsoft, Intel, eBay, Apple, and Google, as well as creating bull call spread positions in Microsoft and Apple and writing puts on eBay. 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.


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