We believe the just announced Microsoft/LinkedIn marriage can work, even if there are likely some very tough times ahead as both companies combine awkwardly. At its core, the deal unites two giants in their respective sectors both hungry for faster growth. Microsoft is growing 5-10%, despite spending billions on Nokia and Skype. LinkedIn has slowed from near 80% annually to more like 35%. In relative terms, both are falling behind their respective peers.
To drive faster growth, Microsoft will need to ramp LinkedIn’s too-slow, unimaginative product development efforts. What started as a recruitment tool should by now have evolved its Sales Navigator product (helping you learn about prospects) into much more than the current 7% of revenue, and its LinkedIn Pulse news dashboard (what is happening to people and companies you care about, and that affect you) into a much higher-profile offering. None of its product initiatives comes close to what Facebook has done with Messenger; effectively creating a brand new, independent business within Facebook. Perhaps only its $90m Pulse acquisition has shown some glimmer of potential. And how has it leveraged the $1.5Bn it spent buying online education video leader Lynda.com? Enough said.
Microsoft for its part is literally nowhere in social networking. The closest it has gotten is Skype, which should have given it a platform to help users engage with the 5-50 people closest to them, who they talk to most frequently. Yet while Facebook and Instagram have advanced hugely in just a couple of years, Skype basically looks and acts the same way it did when Microsoft bought it, except maybe for irritatingly tight integration into Windows 10. Hardly anyone thinks of Skype as a way to engage more broadly with people closer to them.
Neither buyer nor seller has shown themselves to be A+ in product development, but there is clear potential. Maybe the integration of Cortana functionality, and the tighter coupling of LinkedIn’s comprehensive data sets with tools such as Microsoft Office (getting info about people you are meeting delivered to you as part of the meeting invite etc.), can create enhanced, and maybe compelling, office productivity tools. Microsoft’s Dynamics CRM product could certainly do with some differentiation; LinkedIn’s individual background data can certainly help Dynamics users prospecting for new customers. One thing is for certain; tying up with Microsoft gives LinkedIn the potential at least to move beyond the recruitment/job-hunting segment.
But fundamentally the deal has a good chance of working because it is cheap enough that even if Microsoft under-delivers, they will make enough money on it to benefit shareholders. Perhaps that’s a strange thing to say about a $26B cash pay-out, but LinkedIn is the only social/networking player of any scale which can be acquired affordably. Microsoft is buying LinkedIn for less than it was trading for in January on the market before its earnings miss. In the current market, given social/network valuations, that qualifies as dirt-cheap.
It also delivers nearly $1B in EBITDA before stock compensation expense, and that is growing at double digits. It may not be ridiculously cheap, but it is only one year of cash flow for Microsoft. And with such slow growth, Microsoft’s alternative is giving yet more cash back to shareholders. Spending $26B to get near $1B a year of operating profit growing at a good clip before synergies seems a financially astute bet, even for a company as prone to M&A failure as Microsoft.
Posted by Victor Basta @MaExits