I read a fascinating article on Minyanville. The author, Andre Mouton, believes that investing into web properties could be a fool’s game. It is a great article; I definitely recommend all of you to read it.
Andre Mouton believes that Yahoo! Inc. (NASDAQ:YHOO) could have run itself into a ditch with its recent acquisition:
One of Yahoo! Inc. (NASDAQ:YHOO)’s biggest difficulty has been in investing into web properties at a profit. In certain cases, it lands a home-run (Alibaba), but sometimes the company falls short by buying into web properties like Flickr.
Web properties are known to move through the life cycle curve at a very rapid pace. Rapid growth, maturity, and decline could happen all within a single decade. Sometimes, product demand declines due to perfectly natural causes like changes in the technology landscape, or better alternatives. In the end, the market constantly changes. It ebbs and flows in an unpredictable and never ending manner.
What sounds like a practical investment opportunity sounds ridiculous weeks, if not months later. The decline of social networks and the rise of new ones are something that makes it difficult for fully matured technology companies to invest into. Infant web properties like Flickr, MySpace, Deli.co.us, are all examples of what was once hot, now is not.
Silicon Valley executives have done their best to understand the constantly changing business environment. By understanding the environment, they have come up with a workable way to generate returns like clockwork.
How fully matured technology companies sustain growth
Yahoo! Inc. (NASDAQ:YHOO) has cut sales, general, and administrative costs by 27.6% over the past five years, the company also cut research and development expenses by 27.5% over the past five years. The spending cuts allowed the company to grow net income by 841% over the five-year period. The cash that was used on R&D and sales expenses was re-directed to M&As.
Yahoo! Inc. (NASDAQ:YHOO) isn’t hoping for every M&A to turn into a smash-hit success. What Yahoo! Inc. (NASDAQ:YHOO) is hoping to accomplish with an acquisition strategy is to increases its odds of buying into a successful web-property prior to hitting the rapid growth phase. Just one successful attempt at this can lead to solid returns on investment. A good example of this is Yahoo!’s successful purchase of Alibaba for $500 million which it sold for $7.1 billion. This proved that Yahoo! can successfully identify phenomenal investment opportunities. Yahoo! operates a business that is sort of similar to modern day private equity.
Private equity companies are armed with some of the world’s smartest people from business schools. Many private equity managers will acknowledge that most web-based companies will lose money and will be non-existent in the next five years. The companies that go onto become successful (1 in 10) will make up for the other nine that are losers. Yahoo! Inc. (NASDAQ:YHOO) is just like any other private equity firm. As long as one in ten of its acquisitions succeed and the other nine lose, Yahoo! will be able to make up for it by turning in great returns on investment as it did with Alibaba.
Yahoo! isn’t the only one
Google Inc (NASDAQ:GOOG), similar to Yahoo!, would probably go on acquiring companies in order to sustain growth. In certain instances, the company is focused on strategic acquisitions. Sometimes, Google Inc (NASDAQ:GOOG) goes out and buys small web properties.
The company is focused on generating yields from its investments. More importantly, Google Inc (NASDAQ:GOOG) is trying its best to deplete the cash balance on its balance sheet. The company currently has $48 billion in cash and short-term investments (short-term investments are highly liquid investments that can be sold immediately). The company has brought in $16 billion in cash from its business operations in the last year alone. Google cannot afford to keep money lying around.
So, over the course of a single year, the company has invested aggressively into companies like Zagat ($151 million), Meebo ($100 million), Wildlife Interactive ($450 million), and Channel Intelligence ($125 million). The buyouts may not lead to any returns on investment, but sometimes, the one in ten investment does.
Some may criticize Google Inc (NASDAQ:GOOG) for wasting shareholder money. But then again, no one knows what will work and what will not. In 2007, Google bought out DoubleClick for $3.1 billion. The company provided unique information for advertisers which helped measure the return on investment from marketing dollars. Following the successful integration of DoubleClick, Google Inc (NASDAQ:GOOG) was able to grow earnings by 36.60% year-over-year in 2007; this was followed by 54.25% year-over-year growth in 2009. Providing added transparency and analytics to advertisers is what turned web-based monetization from being a fool’s game into a real world science.
Microsoft Corporation (NASDAQ:MSFT) is another company recognized for its brilliance in M&A. The company spends a lot of money in mergers for similar reasons. No one knows where the next smash hit in technology is going to be. So, the best strategy is to diversify aggressively and to ruthlessly optimize core business operations in order to divert profits into acquisition activities.
Microsoft Corporation (NASDAQ:MSFT) purchased Fast Search and Transfer in 2008 for $1.2 billion. This Norwegian company made Microsoft’s Bing search engine more effective at indexing searchable content. The Bing search engine has been able to gain 0.4% market share against Google, according to ComScore. Microsoft Corporation (NASDAQ:MSFT)’s market share gains can be somewhat attributable to Microsoft’s $1.2 billion investment into search engine technologies.
Conclusion
Technology companies have leaned towards a bit of a private equity business model. The advantages include favorable tax treatment, somewhat inflated earnings figures through higher gross margins, and accumulation of intangible assets.
No one truly knows where the next $100 billion idea will come from. Maybe, Microsoft is sitting on top of it with its recent Skype purchase that was valued at $8.5 billion. Maybe, Yahoo! Inc. (NASDAQ:YHOO)’s investment in Tumblr could be worth $10 billion in 20 years. Maybe, Google Inc (NASDAQ:GOOG)’s investment into Motorola Mobility will be worth five times as much.
In the meantime, technology giants will do their best at buying their piece of real estate before it turns into Manhattan.
The article Why Tech Giants Play the M&A Game originally appeared on Fool.com and is written by Alexander Cho.
Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google and Microsoft. Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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