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Analysts Are Undervaluing The Defensive Play In MSFT-LNKD

|Includes: AAPL, AMZN, CRM, DATA, GOOGL, IBM, MSFT, Microsoft Corporation (MSFT), QLIK

Article Summary

  • Microsoft bought LinkedIn for a whopping $26.2B
  • While it was expensive, it will prove to be worth it
  • Improvements in Microsoft CRM, AI, Cloud, and Office products will bring more customers to a subscription model and drive revenues

Deal Summary

Microsoft (NASDAQ:MSFT) recently purchased LinkedIn (LNKD) at a 50% premium for $26.2B. Microsoft's largest acquisition, and first under CEO Satya Nadella, has come under fire from analysts. However, once LinkedIn's platform is integrated into the Microsoft ecosystem, revenue-generating synergies will drive sales much more than anything LinkedIn could have done on its own. Moreover, keeping LinkedIn out of the hands of their competition will pay dividends for Microsoft down the road. The acquisition will prove a profitable venture that vindicates Mr. Nadella, although analysts might not hail him as a hero any time soon.

The subscription-based revenue model has become central to Microsoft. Competitors such as Apple are only starting to realize the promise of such a model and are slowly following suit. Microsoft's ultimate goal is to shift their customers to a subscription, and this acquisition will help them to do so by improving their products to attract and retain more customers.

Improvements to Microsoft's Offerings

Microsoft Dynamics, their enterprise business solution suite, will see a huge boost. The acquisition allows Microsoft to break into social selling, outfitting their CRM tools to allow for warm introductions through the LinkedIn network. Gartner shows that Microsoft controls about 4% of the CRM software market, well behind Salesforce (NYSE:CRM) at 20%.The acquisition will help Microsoft keep up with Salesforce in capturing share from the small players who still control over half of the market. If Salesforce had won the bid, Microsoft would barely stand a chance in the CRM market.

Cortana, Microsoft's venture into machine learning and artificial intelligence, will become much more human. With an established social network, Microsoft can build out the natural human aspect and social integration of their personal digital assistant to put her a step ahead of IBM Watson (NYSE:IBM), Amazon Echo (NASDAQ:AMZN), Apple Siri (NASDAQ:AAPL), and Google Now (NASDAQ:GOOGL). She will curate a centralized newsfeed that will integrate social with personal and work information for her subscribers. As examples, Cortana could let someone know what his colleagues have been doing recently, provide background detail regarding a prospective client, describe coworkers' history and experience before a team meeting, etc. Additionally, coalescing everyone into a newsfeed will drive ad revenue, as Facebook (NASDAQ:FB) has proven their newsfeed to be extremely profitable.

Microsoft Office will become more collaborative and interactive on behalf of the network as well. LinkedIn recently acquired the education website Lynda, which will make it easy for customers to learn about Microsoft's software and take full advantage of it. Microsoft could also bundle a course subscription with an Office 365 subscription. If customers would rather not take an online course, they can refer to their network to find experts, where they can find work shared on their profiles as well. Having an established network will also benefit Microsoft's collaborative tools, an area that Google dominates. There are disparate Microsoft Office communities on the internet, but now with one, large centralized network, Microsoft can drive conversation about their products among everybody.

Microsoft Exchange and Office 365 are both leaders in their respective markets, but other products are starting to make their way in. Microsoft leads the cloud email market with 8.5% share, but Google is closing in with 4.7% with the help of strong adoption by small clients. Moreover, Google has started encroaching on Office with Google Apps for Work (such as Docs, Sheets, etc.). Business intelligence tools such as Tableau (NYSE:DATA) and QlikView (NASDAQ:QLIK) are not making it easier for Microsoft either. As a prudent defensive move, the acquisition will boost the capabilities of the Microsoft suite and help them protect market share.

But was it worth it?

It's pretty hard to deny that the acquisition was expensive, but Microsoft paid an acceptable price. Microsoft intended to offer $160 per share, a 22% premium, but ended up paying $196 per share after a bidding war with what appears to be Salesforce, Facebook, and Google. While the price tag was technically a 50% premium, it was only 14% greater than LinkedIn's 200-day moving average. LinkedIn's stock fell 43% in February during what Forbes called LinkedIn's "worst day ever". If Microsoft paid that much in January, it would have been an 8% discount on LinkedIn's then-200-day moving average. The setback came on the back of an announcement from that LinkedIn would miss Wall Street's estimates due to underperforming ad sales, but Microsoft expects to be able to improve those ad revenues with the Bing Ads platform.

Wrapping it all up

Ad sales alone aren't enough to justify the acquisition, as Microsoft paid just under $250 per active profile. Facebook on the other hand is just above $200 per active profile considering their $332B market cap and 1.65B active users. Facebook makes much more from ads on its profiles than LinkedIn does, but Microsoft didn't acquire LinkedIn solely for ad revenue. With the new tools and capabilities, Microsoft and LinkedIn will provide a better product, move customers to a more profitable subscription model, and defend their leading position in the professional world.

Disclosure: I am/we are long CRM, AMZN.