Rumors of two huge acquisitions in the tech world have swirled over the past two months. The first is Intel's (NASDAQ:INTC) possible acquisition of chip maker Altera (UNKNOWN:ALTR.DL). The second is Microsoft's (NASDAQ:MSFT) potential takeover of cloud computing giant Salesforce.com (NYSE:CRM).
Altera rejected Intel's initial buyout offer for $54 per share, or over $16 billion, back in early April. But that offer, which represented a 29% premium at the time, isn't off the table yet. The two companies signed a "standstill agreement" which will let Intel attempt a hostile takeover if a deal can't be reached by June 1.
Meanwhile, a recent Reuters report claims that Microsoft possibly dropped its Salesforce bid due to the latter's massive market cap of $48 billion. Microsoft neither confirmed nor denied those reports.
Even if these megadeals never happen, the rumors highlight weaknesses in Intel and Microsoft's businesses that need to be addressed. Let's discuss the benefits and drawbacks of these two deals, and which is more likely to happen.
If Microsoft buys Salesforce ...
Microsoft CEO Satya Nadella recently predicted that his company could generate $20 billion in annual cloud revenue by 2018. To fulfill that promise, the cloud business would need to grow more than 40% annually -- which could be tough since IBM, Amazon, Google, and others are all eyeing the same market.
Microsoft's cloud revenue comes from three main sources: Office 365, Dynamics CRM, and Azure. Of these three, Office 365 generates the most revenue through subscriptions to its cloud-based productivity apps.
Dynamics CRM, which competes directly against Salesforce in the cloud-based customer relationship management (CRM) market, comes in second. Dynamics CRM claimed 6.8% of the CRM market in 2013 with $1.3 billion in annual revenue, according to Gartner. Salesforce controls 16% of the market, recently topped $5 billion in annual revenue, and aims to double that figure to $10 billion in a few years. Therefore, buying Salesforce could certainly help Microsoft to hit its $20 billion goal.
Buying Salesforce for over $50 billion would likely be done with stock or by issuing new debt, since most of Microsoft's $95 billion in cash remains overseas. But the real issue is valuation. Salesforce has impressive top line growth, but it's unprofitable on a GAAP basis and trades at 9 times sales -- considerably higher than SAP and Oracle's respective P/S ratios of 4.9 and 4.6.
If Intel buys Altera ...
Despite dominating the PC and server markets, Intel hasn't gained much ground in the mobile market against ARM Holdings' licensed designs.
That battle has now shifted to other markets, including wearable devices, Internet of Things (IoT) objects, and microservers. These products require small, flexible, and power-efficient chips instead of powerful ones designed for PCs or servers. To keep pace, Intel launched its own IoT division in late 2013, which now houses the button-sized Curie module and the SD card-sized Edison computer. Last year, Intel's IoT revenue rose 19% year over year as operating income climbed 12%, accounting for roughly 4% of the company's top and bottom lines.
That's why Intel needs Altera. Altera's chips -- which can be reprogrammed after a product has been shipped -- can be used in a wider variety of products, including cars, consumer devices, and airplanes. These chips, known as field programmable gate arrays (FPGAs), are less powerful but more flexible than Intel's own chips. Intel previously worked with Altera a few years ago on the E6x5C, which featured an Intel Atom CPU connected to an Altera Arria FPGA.
This makes Altera an ideal fit for Intel's IoT division. IDC forecasts that the worldwide IoT market will grow from $1.9 trillion in 2013 to $7.1 trillion in 2020, which could help Intel escape the ongoing slowdown in PC shipments. But once again, the issue is valuation. Intel's offer of $54 per share, which values the company at 35 times trailing earnings, reportedly still wasn't enough for Altera. By comparison, Altera's main FPGA rival Xilinx trades for 19 times earnings.
The bottom line
In my opinion, Intel buying Altera makes more sense than Microsoft acquiring Salesforce. Salesforce is pricey, unprofitable, and would weigh down Microsoft's bottom line growth. Instead of expanding Dynamics, Microsoft should invest in Azure, since Amazon recently demonstrated that providing the cloud-based backbone to sites and apps with AWS can be profitable.
Intel's potential acquisition of Altera could help it widen its defensive moat against ARM's partners on multiple fronts. However, like Microsoft, most of Intel's cash remains overseas, which means it would also have to issue debt or use lots of stock to seal the deal. It also should be wary of overpaying for Altera, which is already trading at a premium to its market rivals.
Leo Sun owns shares of Apple. The Motley Fool recommends Amazon.com, Apple, Gartner, Google (A shares), Google (C shares), Intel, and Salesforce.com. The Motley Fool owns shares of Amazon.com, Apple, Google (A shares), Google (C shares), and International Business Machines. 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.