The mega US$26bn acquisition of Linkedin by Microsoft, which will see world’s largest professional cloud joining hands with world’s largest professional network has caught the attention of users and professionals alike. Through the medium of this article, we attempt to break down various facets of the deal and try and make sense whether the acquisition is strategically and financially attractive for both the companies.
OVERVIEW OF THE TRANSACTION
The all-cash transaction of US$26bn, which is expected to be financed primarily by debt will see Linkedin shareholders receive US$196 per share. The acquisition is the biggest in Microsoft’s history (Figure 1). Post regulatory approvals in the US, the EU, Canada and Brazil and with no competing bids expected because of the sheer size of the deal, the transaction is proposed to close by the end of the calendar year 2016.
Figure 1: Microsoft’s biggest deals
Post announcement of the deal, share prices of Linkedin surged by 47% to US$191.21 while share prices of Microsoft fell by 2.6% to US$50.14
Microsoft dominates the traditional workspace activities by offering a wide array of tools and is perceived as a ‘go to’ place for executing work; however, it has very few tools which connect different people electronically as they work (see Outlook and Skype). Through the acquisition of Linkedin, Microsoft seeks to encompass the entire workspace of an individual / corporate by virtually putting ‘desktop work’ on network and facilitating seamless interaction between the space inside and outside of the office.
Further, the deal helps Microsoft enter the consumer web boom – an area dominated by Google and Facebook while at the same time, ensuring it sticks to its core competencies (with Linkedin connecting office professionals). To leverage on the existing brand, Linkedin will retain its distinct brand, culture and independence with Jeff Weiner continuing as the CEO and reporting to Satya Nadella.
Speculations were also rife that similar technology / social networking companies may be acquired by the larger players having huge reserves of cash. Some of the reasons why such target companies look forward to being acquired include softening of the economy and inexperience in scaling up. Twitter, Groupon, Fitbit and LendingClub are some of the potential target companies; for that matter, share prices of Twitter jumped by 9% on news of the Microsoft-Linkedin deal.
Integration of Core Competencies
Linkedin is proposed to be integrated into various Microsoft Office tools which will make learning of the outside professional world convenient and simultaneous. Quick profile checks before meetings, getting to know of live feeds and integration of information in silos are some of the major benefits.
Data Analytics and Artificial Intelligence
Microsoft could build Linkedin into a major customer relationship manager software such as Salesforce.com with the current analytics prowess at its disposal. The analytics and live feed provided by Linkedin can also be used in Microsoft Dynamics CRM. Cortana, the digital assistant provided by Microsoft will seek to manage professional life better with more information available.
Linkedin shareholders received a premium of nearly 50% of the share price (price before the deal was announced); however, the share price at US$196 is still at a discount of 28% of the share price high that it had reached in early 2015. This has mainly been account of failure to meet expectations and stagnation in use of the platform.
With Linkedin now in a position to gain access to the large platform and distribution services provided by Microsoft, it seems to be a winning situation for Linkedin as it can leverage Microsoft’s resources which is also reflected in the rise in the price of its stock after the deal announcement
Other Major Benefits
- Microsoft is seeking to move more into the corporate customer segment rather than the conventional regular customer segment. Acquisition of Linkedin helps Microsoft gain valuable insights into the corporate world (such as impending project work)
- Linkedin had acquired a company (Lynda) that facilitated online learning and education. Integration into Microsoft products will enable greater accessibility and awareness of such programmes
- Cost synergies to the tune of US$150mm per annum expected by 2018
Operational Concerns – Microsoft’s Track Record of Acquisitions
Microsoft has been pretty infamous in dealing with many of its large acquisitions, especially the ones which are outside of Microsoft’s core domain. After the acquisition of Nokia, Microsoft has been busy firing Nokia employees as part of restructuring and has written down value of its investments. Microsoft actually wrote down this acquisition by $7.6 billion a year later about the same price at which it had acquired Nokia ($7.2 billion). Skype promptly lost ground to better options such as Facebook and WhatsApp. Online advertising firm aQuantive, acquired to match Google’s advertising business failed because Microsoft did not know how to run it. Yammer has been relegated to an insignificant position in Microsoft.
Many experts have commented that the deal value is on the higher side. The consideration implies that Linkedin is paying US$247 for every current active user of Linkedin, which is a pretty steep amount in itself considering the revenue model of Linkedin. Thus, it is necessary that users keep on getting added on to the platform. However, there are concerns around the addition of new users given that Linkedin already has a registered user base of 430mm.
Users might be concerned about the use of information available on one portal on a different portal – something which even Mr. Nadella has acknowledged. Also, companies might not approve of employees using a social networking site during work hours, even though it might be useful.
Inspite of the healthy cash reserves at Microsoft’s disposal, the use of debt for financing of the deal has raised certain eyebrows. Microsoft, one of only 2 companies in US with a AAA credit rating might see a possible downgrade in its rating by Moody’s with its gross debt increasing to 2 times EBITDA.
The larger opinion has been that at US$26bn, Microsoft has overpaid for Linkedin. The valuation was arrived at using 8.1x trailing 12 months revenue and 6.7x forward 12 months revenue, whereas TechCrunch has estimated that average SaaS revenue multiple for a publicly traded company is 4x – 6x.
We also ran an independent DCF valuation of Linkedin as a standalone entity (i.e. without considering the possible synergies on account of the acquisition) but reflecting risk profile of LinkedIn and its peers with an implicit assumption that over the time LinkedIn’s capital and the cost of capital will gravitate towards industry average. We arrived at price per share US$89.1 for LinkedIn (pre synergies). We have also provided a sensitivity analysis of our DCF with respect to the assumptions regarding WAAC and terminal growth. Our DFC analysis price is at a 35% discount to the pre-acquisition price of the LinkedIn (5 month average price before the acquisition announcement). Microsoft’s acquisition at US$196 represents a step premium of 120% over the fundamental price of the LinkedIn.
Microsoft expects the deal to be EPS accretive by FY19. Our analysis, however expects the deal to be accretive only by FY20. Accretion improves with smaller offer premium. However, premium below 30% would have been highly unlikely to incentivize LinkedIn shareholders.The value of the investment thus arrived at was US$11.50bn indicating that the present value of the synergies that must be generated on the deal must be US$14.50bn. A back of the hand calculation shows annual post tax synergies till perpetuity must be US$786mm to justify the deal consideration, which is way higher than the US$150mm annual cost synergies expected by Microsoft. The deal has to accordingly generate sufficient revenue synergies for the purchase price to be justified.
Based on the above calculations, the deal does seem to be risky for Microsoft in terms of generating its required returns and it might not have been a bad idea for a certain proportion of stock in the purchase consideration to share the risk so arising because of the uncertainty. This is exactly what Facebook did in its $22 billion acquisition of WhatsApp which was financed 82% by stock. In spite of the above calculations which are derived using rational assumptions, the Linkedin bet does not seem to be a bad one because of the quality of its user base as explained below.
The deal has evoked mixed reactions from different quarters. Credit Suisse sees the potential for strategic synergies between the two companies. UBS says the deal makes strategic sense but wonders whether there will be a culture clash between Microsoft’s more grown-up culture and the younger Linkedin. BMO Capital Markets, on the other hand suggests Microsoft could have done better for US$26bn. As interesting it will be to see the future paths of the merged entity, the deal could also widespread implications on consolidation in the global technology sector.
EXHIBITS AND REFERENCES
Exhibit: Brief Profiles of the Companies
Note: This article has been authored by Mohit Pimpalkar & Yash Baheti from BETA – The Finance and Investments Club of IIM Ahmedabad. For much such articles go to https://betaiima.wordpress.com/
Annual Reports of Microsoft and Linkedin, Microsoft Investor Presentation, Bloomberg, Reuters, The Economist, News runs, Data provided by Damodaran (NYU Stern)