Microsoft Buys LinkedIn: The Value of a Huge Directory
So Microsoft has acquired LinkedIn, for a $26bn cash consideration. Leaving aside the possibility Satya Nadella thinks he's finally found a way to stop them sending him so much e-mail, what is Microsoft thinking?
The bear case is pretty clear. LinkedIn lost $166m for 2015, and Microsoft paid a premium of nearly 50% over Friday's closing price. The losses are getting worse, too - in Q1 2015, the company lost $17m at the operating level, which had risen to $66m in Q1 2016, putting them dangerously close to beating 2015's loss in the first half of 2016. Meanwhile, Microsoft shares fell 2.6% on the news. Depending on whether you like total users or monthly-active users (MAUs), Microsoft paid somewhere between $60 a user and $250 a user. The deal values LinkedIn at 7 per cent of Microsoft's market capitalisation, as much as Sky TV. Really... is it worth that much?
Also, over the last two years, LinkedIn spent 16 per cent of its revenue, or 96 per cent of its operating income, paying its employees in stock. With the shares having gone from a peak of $225 to $100 after the Q1 profits warning in February, its key employees were looking at a massive pay cut unless they found a buyer. In Q1 2017, LinkedIn is due to implement new FASB guidelines that might force it to recognise more of the stock options as costs.
And Microsoft is levering-up. The $26bn purchase is entirely funded with new debt, even though Microsoft has $92bn in net cash on the balance sheet. The obvious point here is that borrowing is outrageously cheap. Further, much of the Microsoft cash pile consists of the profits of its overseas subsidiaries - almost $103bn worth, gross - which it can't repatriate to the US without paying a 35% rate of tax. Using the cash to collateralise a loan makes use of it without having to pay the tax, while the interest charges are of course tax-deductible for the US holding company. Bloomberg estimates that the tax advantage alone is worth $9bn to Microsoft.
So, a big merger motivated by cheap borrowing, tax planning, and insiders looking for an exit for their unrealised stock options. What could possibly go wrong? As the Harvard Business Review points out, between 70 and 90 per cent of mergers fail.
On the other hand, we can probably all think of times when just the right person's business card would have been worth $250, and maybe much more. Nobody would say LinkedIn was the most compelling or best designed of apps. Its infrastructure engineering has a good reputation - it is an early contributor to the Open Compute Project - but Microsoft won't lose any time porting it into the Microsoft Azure infrastructure. But the real value in it is the data, essentially a giant global business directory, the 433 million total names, job titles, CVs, and the links between them.
Microsoft, famously, is a company whose key product is called Office. Its soul is in the enterprise. LinkedIn offers it not just a huge list of e-mail addresses, but a map of the corporate world. And, as our Microsoft: Pivoting to a Communications-Focused Business Executive Briefing argues, it's a company whose revenue growth is coming almost entirely from the combination of the cloud, and communications. The Office 365 suite is tied together by Azure hosting, by its deep integration with Skype for Business, and by Sharepoint's version-control of OneDrive documents (communication for files, if you like).
Office could include details from LinkedIn profiles in meeting invitations, or perhaps better, suggest people you should include. That could go deeper, too - suggestions could be pulled into Word ("Who else should review this?"), PowerPoint ("Consider running these slides by..."), Dynamics CRM ("X has contacts with Customer Y. Contact them now?"), or even Visual Studio ("Ask an expert about this bug report..."). We covered the future of conversational commerce in our WeChat: A Roadmap for Facebook and Telcos Executive Briefing; this would be more like conversational production, the enterprise back-end to the customer-facing front-end.
Microsoft has tried this before, with Yammer, and arguably with the original Skype acquisition. Yammer is an interesting case in point. Microsoft bought it for $1.2bn, a multiple of 40 times earnings, presumably in order to get at its data. However, you'd be hard put to it to show that MS got any value from the deal, certainly not $1.2bn worth. LinkedIn's data property is probably stronger, not just because it is bigger, but because it is much more about links between enterprises and between divisions within them than about links within teams. People generally know who's in their team. Social-graph apps' value proposition, though, is usually that they surface non-obvious relationships by analysing weak ties in the network. LinkedIn's data set is much richer on this score. And the literature on industry clusters is clear that a lot of the productivity boost comes precisely from the existence of a network of experts.
The HBR makes an interesting point in that successful mergers are defined by what the acquirer can offer, not what it can get from the acquired. Microsoft can offer the context in which LinkedIn's data resources can be genuinely useful, and therefore valuable. That context is its drive to own cloud-based, communications-focused business IT.
The potential usefulness should be clear - as should the potential for Clippy-like annoyingness, or else creepy intrusiveness. It's a good rule that whenever anyone proposes to run several data sets containing personal information through an object-linking algorithm, you should probably worry. Bulk-matching LinkedIn profiles with Skype, Skype for Business, Microsoft, Yammer, and other accounts is precisely the sort of thing that's likely to throw up unpredictable compliance problems.
And surfing the web of weak ties across the boundaries of corporate hierarchy may sound fun and useful, but another way of looking at it would be a serious threat to information security, the old-boy network on an industrial scale, or a great opportunity for major compliance issues in businesses like financial services or the law. What happens when Excel suggests an analyst should contact the broker on the other side of the Chinese wall? Or a trader at a counterparty? Or Visual Studio accidentally tips off a competitor as to what you're developing?
For now though, all that speculation is a little down the line. It's always hard to tell if such deals are going to pay off although the HBR marker would suggest caution is always a good bet. Having said that, Microsoft has done good stuff in the cloud recently - even some of the staunchest MS-Haters we know like Office 365, and its done a good job integrating Skype for Business.
To us, the fit looks good for Microsoft, although it potentially makes it even more challenging for telcos over time as it could be one less reason to use phone numbers - or the PSTN.