On this episode of Industry Focus: Tech, Motley Fool tech and telecom analyst Dylan Lewis and contributor Daniel Sparks go over what investors -- especially investors in LinkedIn -- should know about the deal. Listen in to find out:
- What potential value Microsoft sees in LinkedIn, both on the consumer and the enterprise end
- Why LinkedIn's stock price has seen a slow decline since the news of the acquisition
- Why this deal is different for Microsoft than its less-than-successful acquisitions of Nokia and aQuantive
A full transcript follows the video.
This podcast was recorded on June 17, 2016.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, June 17th. We're talking LinkedIn and Microsoft. I'm your host, Dylan Lewis and I'm joined on Skype by [Fool contributor] Daniel Sparks. Daniel, how's it going?
Daniel Sparks: Good, how are you doing?
Lewis: Doing all right. I'll say, Daniel, in preparation for this show, I sent you a LinkedIn connect request, and I haven't gotten confirmation that you accepted it.
Sparks: Oh, awesome ... I'll take a look at your LinkedIn profile and make sure you're a worthy request.
Lewis: Make sure that the story checks out that I am who I say I am?
Sparks: Yeah, I'll do that.
Lewis: So, the tech news that overwhelmed financial media this week, LinkedIn and Microsoft. Probably one of the bigger mergers in tech history, certainly the largest that Microsoft has decided to take on. Let's walk through the details of the deal.
Sparks: Monday we wake up to a big stock move. LinkedIn and Microsoft announced a big deal. In fact, it was Microsoft's biggest acquisition in history ever, paying $26.2 billion for the company. It comes out to $196 per share, which represents a 50% premium from where the stock was trading before the announcement. That's why the stock moved so big that day.
Mainly, Microsoft made this deal because LinkedIn is a solid investment in its own right. This is evidenced by the fact that Microsoft decided to keep LinkedIn's identity intact as its own unique culture and business, bringing in their CEO, leave him operating the company.
Lewis: So, in a lot of ways, while this is an acquisition, LinkedIn is going to maintain some independence. It seems like they're going to be a sectioned-off business unit in Microsoft in that, while there will be a lot of collaboration and sharing some of the graphs and things like that that connect users on the Office platform and the LinkedIn platform, LinkedIn will keep this unique brand, corporate culture, and identity.
Sparks: Yes, and I think that shows a little bit of difference in the way Nadella goes about his acquisitions. Previously, they really focused on a lot of integrations instead of keeping the business as it is.
Lewis: I think a lot of people are thinking it, what are the compelling reasons for this acquisition? Some people are like, "Yeah, this totally makes sense." Some people are like, "This is a total head scratcher. I don't really see it." What do you see here, Daniel?
Sparks: Microsoft brought up that there were synergies and integrations that could be achieved through this. That is what I think is raising a lot of eyebrows. For instance, some of the synergies that they mentioned were integrating LinkedIn profiles into various Microsoft products such as Outlook or Office, so that when you're doing these collaborative efforts, you have context of who's there. This is an example where something like this could have been achieved easily through a win-win partnership. It doesn't seem like there needed to be a transaction for this to happen. But then, there's also Integrations where it seems to make more sense, like when it comes to CRM, customer relationship management, LinkedIn and Microsoft have some commonalities there, some overlaps, that could be complimentary.
When it comes to synergies, I don't see this as a really compelling reason for the acquisition. But sure, maybe it works out, maybe it doesn't. That's really the approach that you have to use with a lot of acquisitions, just the fact is many of them fail. But as far as compelling in the reason of LinkedIn as a solid business model in and of itself, I think that does make sense, because you have to keep in mind, even though the stock is being purchased at a 50% premium, it's also down significantly from its 52-week high, which was in the mid $200s. As far as it being a business in and of itself, I think that's a key compelling reason for this acquisition. Facebook has shown the longevity of the network effect, especially when it comes to social media business models. I think the network effect can be powerful there. LinkedIn is a successful business. Sure, they're still young and growing. But they don't have any key problems that make it look like it couldn't succeed in its own right.
So, that's the compelling thing I see there. LinkedIn is a solid business in and of itself.
Lewis: Yeah, it seems to me like the things that consumers are going to see from this deal, your everyday internet browser, doesn't really support the deal all that much. It's more on the enterprise side, the CRM side. I think Microsoft seems to see a lot of value in the navigator tool that LinkedIn has. You see them on the presentation in the press conference that they announced this deal on, talking about the integration of the news feed and using LinkedIn profiles within Outlook so you have a more robust understanding of who you're talking to, and it's like, "Man, that does sound like the kind of thing they could have achieved in a partnership." I don't know that that was something that needed a $26 billion price tag attached to it. But on the CRM side, maybe there's something more.
Sparks: Right, yeah. And Microsoft actually brought up that while this is a complementary acquisition, the huge focus here is that it's additive. You kind of see that when they brought up a slide of the addressable markets. Microsoft defines LinkedIn's addressable market as basically totally additive, which seems a little bullish and optimistic. So maybe we should raise our eyebrows on that one. They defined LinkedIn's addressable market as $115 billion, where Microsoft is already at $200 billion. So, Microsoft sees this as a huge addition to their opportunities. That's one way we could think about it, too.
Lewis: Yeah, and the penetration for that market right now is in the single-digit percentage. I think their trailing-12-month revenue is somewhere in the neighborhood of $3 billion.
Lewis: There's certainly quite a bit to realize there, but I do agree, it's a little ambitious. Looking back, Microsoft is not a company that is known for very great choices with their acquisitions. I think their track record highlights some of the issues with making big acquisitions. Do you want to run through a couple and show some of the risks here?
Sparks: Yeah, so big acquisitions. That is the highlight here. If you were to look at all of Microsoft's acquisitions, it could have panned out fairly well. But when you look at the big ones ... and, obviously, those are the ones that have the most material impact on investors, the ones that matter. Recently, there was a 2014 acquisition of Nokia, which was around $8 billion. Virtually all of this value was almost erased in a matter of a few years. That was just mind-boggling. When it comes to the restructuring charges, and the writedown on the balance sheet ... when you add up all this, basically Microsoft just spent a lot of time firing people, getting rid of people, reorganizing stuff, and basically getting rid of the business. It was a complete failure. The total charges were probably somewhere around $10 billion that was wasted on this deal.
Lewis: What about the aQuantive deal? That was a little further back, but the story is kind of similar there.
Sparks: Yeah. aQuantive was an acquisition made to keep up with Google. Google was hot stuff and Microsoft wanted to up their game there so they wanted a piece of [it]. aQuantive specialized in digital advertising products. Same thing, virtually almost all of the value was completely erased. This acquisition was around $6.2 billion, and the writedown was pretty much the entire value of this business. And like we mentioned earlier, these are different types of acquisitions, too, which came before Microsoft's new CEO, which were more focused on integrating these into the business. With LinkedIn, they're really trying to emphasize that LinkedIn is valuable in and of itself. So maybe that'll help avoid some of the downfalls that could come from integrating such a different business.
Lewis: Yeah, I think if you want a metaphor for how to think about these acquisitions in Microsoft's history, the Nokia and aQuantive acquisitions are kind of like buying a car that has working parts but you need to fix it up a little bit. Buying something like LinkedIn is like buying a car that runs. It works on its own. You don't need to put in work to get a lot of the value out of that you see. Granted, there's a premium there, but in and of itself, it's a pretty strong business.
Sparks: Yeah, definitely. That brings us into another one of the risks for this company, for this acquisition -- the premium, the high price that they're paying. While, like I said earlier, the stock is down from its 52-week high, the 50% premium Microsoft is paying highlights the huge difference between what the market thinks LinkedIn is worth today and what Microsoft thinks it's worth. $3.2 billion in revenue for LinkedIn, and you're paying $26.2 billion, that already highlights that LinkedIn is a really forward-looking valuation, which does make sense. The revenue is growing. But it highlights the fact that if you pay a higher price, there's a greater risk to the value actually coming through. That's one of the key risks in this acquisition.
Then, like we said, the proposed synergies that they're talking about are little bit questionable. I see the value as the business itself, but I don't know. Some of these are a little funky.
Lewis: Yeah. I will say, the purchase price, trailing-12-month revenue of $3 billion, you look at the purchase price of $26 billion, that puts them at about 8 [times] sales, which isn't outrageous, as far as acquisitions go. But it is expensive. That $196 is around where they were trading prior to offering up that lackluster guidance and that revised outlook on what 2016 will be. There are a lot of shareholders who have seen the price around here or even higher during the time they've owned it.
Sparks: Yeah, that highlights that it is trading lower. It depends on how you look at it. Zoom out a little bit, which is usually the best practice, and Microsoft is being somewhat prudent. At least they didn't purchase it when it was trading around $260.
Lewis: Right. We got a question from a listener related to the acquisition. The question was, "Microsoft has $100 billion in cash, most of its overseas, would they pay taxes on the cash repatriated for the purchase of LinkedIn?" Reading through the announcement and the conference that Nadella did, they made it clear, they're going to finance this transaction through a new debt. They're going to issue a new debt to finance all of this. The short answer is, the company isn't planning to use any cash for this deal, or, they're not using that existing foreign cash hoard for the deal, so that doesn't come into play here.
More broadly, in terms of how to think about that cash that's held abroad, if they were interested in using that money to fund activity in the U.S., they should have to pay taxes on it when they're repatriating, but there are companies that have found ways around doing that. And there's actually a really excellent article from Bloomberg, it's a little dated, it's from 2010, it's called "Dodging Repatriation Tax Lets U.S. Companies Bring Home Cash." Because it's a little bit old, the practices aren't going to be totally up to date. But I think this article gives you a really good sense of the incredible game of cat-and-mouse that goes on with offshore cash, and the people who are trying to enforce the tax laws and the incredible financial resources that are put to circumventing them or avoiding them. There's always a huge difference between tax evasion and tax avoidance.
If you reach out to the show, we can send you that. Like I said, it's not totally up-to-date, so the practices might not be totally current, what companies are doing today. But it is an interesting look at this side of the tech space. And we'll probably do a show on offshore cash at some point in the future, because it's a very interesting topic.
Before we get off debt issuance all together, I read this morning that following the announcement of the deal, and the fact that it's going to be financed by debt, Moody's said that they'll be placing Microsoft's AAA credit rating under review, and there's a possibility that it could be downgraded. Which is shocking to me. There are three, at the moment, businesses that have AAA credit ratings -- Microsoft, J&J, and I'm blanking on the third. Daniel, can you help me out?
Sparks: I'm not sure.
Lewis: I know the Exxon recently suffered a downgrade. But, this revision or under-review nature of the credit rating is not a reflection of the deal itself. This is something that gets triggered by the debt-to-EBITDA ratio that the company maintains. You'll see this play out over the next month or two, but don't be surprised if you see this happen. This is something that's been flag-posted.
Of course, all of this discussion that we're having is contingent on the deal actually going through. The company's board has signed off on the deal, but it's not necessarily a done deal. There's still shareholder votes and the regulatory approval process. For the sake of discussion, let's assume everything goes smoothly here. At the end of the day, it feels like this is something that LinkedIn shareholders should be happy about.
Sparks: I think so. We can kind of think of the LinkedIn shareholders as in two groups. This might be over simplifying it. There's those who have owned the shares for a long time, and have always believed in the bullishness of the business. And the shares might still feel trading lower to them, in that case. These guys are big believers in the business and might want to hold onto the shares, whether this plays out or not, because either way, they believe in LinkedIn. And, there's those who came in seeking a bargain after the sell-off that's occurred recently. For them, this could be a way to cash out.
Either way, it's a win for LinkedIn shareholders.
Lewis: And you have to love an all-cash deal as a shareholder. You are not being stuck with Microsoft stock as a LinkedIn shareholder. You're getting cash, you're getting a pretty nice premium on current share price. There are some people who are still down on this position. I noticed in looking at LinkedIn's stock price over the past couple days, the deal was announced at $196, and that's where it traded immediately on Monday. From there, you see it slowly come down. It was around $192 when I checked before the show. Any theories as to why something like that might be going on?
Sparks: Yeah, I think it's just people taking their profits, making sure that they get the best value here. Like we said, we're not sure the deal will actually go through. For someone who came in and bought during this sell-off, which could be a lot of people, because the sell-off was significant, this is a huge gain for them, and they might not want to take the risk to see what would happen if the deal doesn't go through.
Lewis: Yeah, there's some pricing there in the possibility that the deal doesn't go through. A little risk, 2% drop, or something like that. But there's also the case to be made, like you said, these long-term shareholders, that it's worth holding onto and seeing what happens. There's a possibility that it doesn't go through, in which case, if you're a long-term shareholder and you love the LinkedIn business model, there's nothing wrong with holding on to your shares until the deal closes on the off chance that something weird happens and regulatory agencies say, "No, we're not going to let this go through." Then you'll get that 5-10 year look at LinkedIn that you were hoping for.
Sparks: It's also worth saying, there could be a way that this could be negative to some shareholders like that. They might really believe in the business, and that this is a long-term winner for them, and they were anticipating higher returns over a 5-10 year period. For them, it might be a little disappointing, they might feel like Microsoft is getting a steal and taking their potential profits. I guess that's one way it might not be all positive.
Lewis: And that could certainly be the case for some of the people who bought during the highs, when it was up in the $250s. For Microsoft shareholders, it ultimately comes down to how bullish you are to LinkedIn's business prospects. You saw, I think, the day they announced it, Microsoft traded down about 2%. We're obviously not focusing too much on short-term movements here, but that gives you an idea of the market sentiment, and how some Microsoft shareholders were feeling. If you like LinkedIn as a business, and you're a Microsoft shareholder, then I think you have to like this move. If you're kind of agnostic about it, you don't really care, I guess it's kind of a wait-and-see.
Sparks: Yeah. Going back to that incremental addressable market, I think Microsoft shareholders could take a look at those addressable markets, which are basically Talent Solutions, that's the primary one. With LinkedIn's recent acquisition of Lynda, they brought in learning and development. LinkedIn defines that as a $30 billion addressable market as a portion of that $115 billion we mentioned earlier.
Microsoft shareholders can kind of maybe study those addressable markets, it could be a little exercise for them, and see if there's value in these areas, and see if LinkedIn looks like the kind of business that can dominate in these areas and expand their market. That could be one way for them to assess if this is added value or not.
Lewis: Gotcha. Before I let you go, any other thoughts?
Sparks: I'm not a LinkedIn shareholder, so this has been interesting for me to see it from the outside. You and I were talking before the show, and we've gone back and forth about it. But I guess we missed out not buying here. Congratulations to those who did buy during the sell-off. That's an exciting gain. It's nice to wake up and see 50%. I think before that, in the month and a half or so leading up to that, shares were up double digits as well. So that's a pretty big gain in a short time.
Lewis: Absolutely. I know a lot of Fools have been following the company, so there were a lot of happy Fools out there. Thank you for your time, Daniel.
Sparks: Thanks, Dylan, it was fun.
Lewis: Listeners, that does it for this episode of Industry Focus. If you have any questions, or you just want to reach out and say "Hey!", shoot us an email at firstname.lastname@example.org. You can always tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes or check out the Fool's family of shows on fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Daniel Sparks, I'm Dylan Lewis. Thanks for listening and Fool on!
Editor's note: In the podcast it was stated that Microsoft acquired Nokia for around $8 billion, but the price was $7.2 billion. The Fool regrets the error.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Daniel Sparks has no position in any stocks mentioned. Dylan Lewis owns shares of Alphabet (A shares), ExxonMobil, and Johnson and Johnson. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, and Johnson and Johnson. The Motley Fool owns shares of ExxonMobil, LinkedIn, and Microsoft. The Motley Fool recommends Moody's. 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.