In my previous article I discussed why the Microsoft-LinkedIn (NYSE: LNKD) deal made no sense (read why). Microsoft (NASDAQ: MSFT) not only overpaid, the subsequent press release was seen as a mixed pot of mumbo jumbo that included hip but meaningless words like "cloud" and "opportunity." I would be very surprised if any shareholder has a clear vision of what Microsoft is trying to achieve.
Sometimes companies don't like to disclose too much information due to competitive reasons, but now that we have a detailed timeline of what transpired over the couple of months leading up to the transaction, I can say with confidence that Jeff Weiner played Nadella (and by extension Microsoft shareholders) like a fiddle, partly thanks to Nadella's incompetence.
Lack Of Conviction
In an acquisition, especially one that is all cash, the acquirer typically has performed in depth research about the target. This is what we call conviction in investing. By offering an all cash deal, the acquirer will absorb all of the post-acquisition gains and losses (i.e. synergies vs. dis-synergies), which makes conviction even more important.
We know that the acquisition was not a preconceived plan according to the filing, which would have given me a lot more confidence. Instead, the filing showed that it was a rather rushed deal that began in February, with Microsoft starting the evaluation of the potential transaction in March. The events are quite telling. Jeff Weiner and Nadella had a meeting to discuss current business dealings on February 16 th, it was then that a "concept of a business combination was raised." Or in other words, it was a spontaneous decision by Nadella, or the result of top-notch salesmanship from Jeff Weiner.
Source: Page 31 from PREM14A filed on July 1 st, 2016
Tricks From Weiner
After the initial meeting, Jeff Weiner courted two potential suitors, who appeared in the filing as Party A and Party B. According to Recode, Party A is Salesforce (NYSE: CRM) and Party B is Google (NASDAQ: GOOG). What's funny is that subsequent to the discussions with both parties, Weiner called Nadella on March 15 th to tell him that "although LinkedIn was not for sale, others had expressed interest in an acquisition."
Source: Page 31 from PREM14A filed on July 1 st, 2016
So even though LinkedIn was clearly for sale, Weiner conveyed a sense of urgency to Nadella. After receiving this "threat" that Microsoft may be left out of the race unless he acts, Nadella decided to express interest the next day. It was then that Microsoft began to "work on the project [the transaction]." So a month after the initial idea, Microsoft finally started to consider the transaction seriously.
Source: Page 32 from PREM14A filed on July 1 st, 2016
Tell Me What To Say
It was revealed that Microsoft's first offer was $160/share, made on May 4th. This already represented a 28% premium based on LinkedIn's close of $124.54/share, but it wasn't close to what LinkedIn wanted, which was $200/share. Of course, this information was contained within LinkedIn. But how can Weiner get more money out of Nadella? Considering that Nadella is now "on the hook," LinkedIn's management decided to just be more direct. On June 7 th, Reid Hoffman (chairman of LinkedIn) told Nadella that LinkedIn would consider the transaction if Microsoft could up its offer. What was Nadella's response? He indicated that "a discussion of cost synergies in the transaction would be necessary in connection with any potential price increases from Microsoft."
Source: Page 42 from PREM14A filed on July 1 st, 2016
Supposedly, Nadella had no idea just four days before the signing of the agreement of what were the potential cost synergies. Even if he was talking about incremental synergies (i.e. those that were not considered before), was it really possible for Nadella to make a good judgment in under four days?
What Shareholders Should Do
If I had any doubt about my bearish view, it has now been completely obliterated by the new revelations. The chain of events paints a clear picture to me: a management with no vision that is growing for the sake of growth. If I was a shareholder, I would be absolutely furious if I learned that the CEO had to rely on the acquirer to learn about cost synergies. Have you ever heard of a real estate agent telling you how terrible his listing is? Me neither. Nadella would have only learned about the positives from Weiner, and none of the negatives.
Did Microsoft become a terrible company with this transaction? No, but it became a worse company. $26 billion isn't pocket change, but in comparison to the $400 billion market cap, the overall impact will be limited. So Microsoft is still investable, but is it wise to hold it? Maybe, but it definitely isn't a good idea to allocate a large portion of your portfolio to the stock. We look to Microsoft's historical performance for guidance because the business is relatively predictable. But if you have a management that is recklessly making acquisitions, your financial analysis holds a lot less water since what happened a year ago may not be indicative of what will happen a year from now.
A similar situation arose in the V20 Portfolio. MagicJack (NASDAQ: CALL) was this great cash cow that was printing money. Unfortunately, the management decided to make a poor acquisition (at least it was profitable), significantly decreasing the upside. Even then, the stock was incredibly cheap, but that was not an excuse to not act. MagicJack accounted for roughly 20% of the portfolio prior to the announcement, the position was subsequently trimmed to 5%. The point is that when the future becomes uncertain as the result of erratic management behavior, you should not risk a significant amount of your capital. Nadella's behavior during the negotiation has shown me that Microsoft's management is incapable of making rational decisions, hence I believe that investors should not hold a concentrated position in the stock.
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Disclosure: I am/we are long CALL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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