Does that title sound inflammatory? Rhetorical? If so, then I apologize.
Well, OK. Maybe I'm trying to be just a little bit inflammatory. But definitely not rhetorical. You see, rumors have apparently been floating around about Microsoft's (Nasdaq: MSFT) desire to buy rival computer peripherals maker Logitech (Nasdaq: LOGI). Flush with cash, the carpetbagger from Redmond may spend $8 billion to bag a large part of the market for such PC necessities as keyboards, mice, and webcams.
The rumors have gotten so active that this weekend, Logitech's own chairman was prompted to respond -- and shoot them down. Quoted in Italy's Corriere della Sera on Sunday, Guerrino De Luca called a potential buyout offer from Microsoft "an operation without sense."
No sense whatsoever?
Dismissing the idea out of hand may be a bit too abrupt, however. There is some logic to such a tie-up. As fellow Fool Rick Munarriz argued back in January, Microsoft buying Logitech would hearken back to Dell's (Nasdaq: DELL) buying Alienware (or, I might add, Hewlett-Packard's (NYSE: HPQ) purchase of Voodoo PC.) It would be a marriage of corporate with cool. Big beige boxes acquiring a coat of paint, and an attitude. Name any PC add-on that Microsoft makes, chances are that Logitech makes it, too. And as Rick put it, "Logitech's accessories are just plain cooler."
You can even argue that absorbing Logitech would make financial sense for Microsoft. After all, Microsoft's "entertainment & devices" division (EDD), which builds both computer peripherals and the Xbox, lost money last year. Meanwhile, Logitech earned a respectable 12% operating margin selling competing wares. Taking Logitech in-house would add scale to Microsoft's hardware business, and presumably make it profitable as a whole.
Thanks, but no thanks
However, if you dig deeper into Microsoft's numbers, I think you'll find a hole in this logic. Microsoft's EDD unit turned the corner midway through 2007, just as it promised last year. Although EDD was unprofitable for the year, the division earned operating profits in the second half. In Q4 in particular, EDD achieved an 11% operating margin. In other words, Microsoft doesn't need Logitech to turn a profit on hardware. It has proven it can do that on its own -- and with the EDD division continuing to grow, I wouldn't be surprised if, before long, Mr. Softie is earning even greater margins than Logitech.
"Greater" is not great
But here's the thing: No matter how strong a business EDD evolves into, it's never going to approach the level of profitability of Microsoft's core software business. Just ain't gonna happen. Microsoft's two largest software divisions, "client" and "business," earn operating margins of 78% and 65%, respectively. And note carefully: I didn't say gross margins. I said operating margins. When it comes to earning a profit on product, software beats hardware any day of the week, and three times on Sunday.
Don't look now, but ...
Not that this would prevent the European Union from arguing the contrary, though, and thus busting up the deal on the grounds that it would hurt competition in the computer peripherals marketplace and unjustly enrich Microsoft in the process. Eurocratic regulators have been dogging American companies for years, extracting pounds of flesh from Coca-Cola (NYSE: KO), GE (NYSE: GE), and Intel (Nasdaq: INTC). But they're most persistent in targeting Microsoft.
I have no doubt that, should Mr. Softy attempt to lock up a new market by buying a European company like Logitech, Competition Commissioner Neelie Kroes would take it as less a slap in the face (and more as an honest-to-goodness stick in the eye) and redouble her efforts to teach the bully from Redmond a lesson. Microsoft could offer $8 billion for Logitech, or it could offer $80 billion -- the deal still won't go through.
Foolish takeaway
So, perversely, if Microsoft were to bid for Logitech, I think I would have to cheer for the EU to quash the deal. Although I'd be more than leery of the means, the ends are what should matter to Microsoft shareholders -- and the key end to root for here is that Microsoft doesn't stray any farther from its core competency in software.
Expanding into hardware is a fool's (note the small "f") errand. If Microsoft has $8 billion lying around, and can't figure out a way to invest it in a software venture that will earn software-worthy margins, it should just return the money to shareholders through another megadividend -- and leave Logitech to the Swiss.
Curious about the other deals the EU has quashed? Learn more in:
