Look like they opted for Plan A – pissing more money down rat holes.
I have to admit I am not exactly shocked that the Park Paradigm isn’t required reading in Redmond. In fact I’m not even sure it renders in IE. (Do you get fired – or worse – if caught using Firefox at Microsoft?) But obviously Steve B. and his non-exec boss Bill G. have either not read my back-of-the-envelope suggestion on what to do with the company, or have chosen to ignore it. Perhaps they had a look, called up a couple of their favorite bankers, and were put off by the fact they hung up when asked to price up a $100bn term acquisition facility… (Fair enough, December 2007 was always going to be a tough month to cobble this kind of deal together. 
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So instead of making the company leaner, more focused, less complex, easier to manage and more appropriately capitalized, they decided to go a different way. More bloat, less focus, more complex, harder to manage and inefficiently capitalized. Hey why not? It’s a plan.
Since writing my suggestion in October, Microsoft has announced the acquisitions of Multimap, Fast Search and now Yahoo. The first two of these three fit the typical Redmond acquisition m.o. :
…Microsoft’s problem isn’t that they have bought bad companies with bad technologies at bad prices. Mostly just the opposite. There are a lot of very smart people at Microsoft, starting at the top. They have bought many really interesting companies with really neat technologies and incredibly smart people. And then they kill them. They don’t mean to. But it is unavoidable. The corporate antibodies in a giant like Microsoft inevitably end up overwhelming the acquisitions (which especially given that by the nature of the industry, most are very young and very fast growing, innovation-driven companies that have not had time to evolve any defenses against mature mega-corporation antibodies. Don’t feel bad Bill, it’s not a Microsoft thing, it’s a Fortune 100 thing. The nature of your business (technology) just exposes you more is all.
The Yahoo acquisition is a bit different, both in scale (ie needle moving, not just a couple weeks free cash flow) and in the sense that it is a mature, struggling big(gish) company (as opposed to a fast growing entrepreneurial start-up); in many respects similar to Microsoft (with the small difference of not having a Windows/Office cash cow equivalent puking money week in week out.)
So is the Yahoo deal fundamentally dumb? Not necessarily. Indeed it isn’t by any means a complete surprise given previous approaches and widespread speculation and commentary on the idea. (I admit to having traded small amounts of Yahoo from the long side over the past 9 months or so basically looking to bet on this deal. I am somewhat pissed off that I was not in the trade when it actually happened.) The logic in this merger is less typical Silicon Valley and more Rust Belt in the sense that it is two mature ex-growth companies with leading market positions looking to rationalize – combine cost centres, share customers, extract “synergies” of course – and to generally give management something to keep busy with for a few quarters so they don’t have time to worry about strategy. Clearly Microsoft and Yahoo have many complimentary, overlapping and duplicative products and technologies so the scope to do some worthwhile and value producing old fashioned consolidation and restructuring is definitely there. For instance, I suspect it would make a lot of sense to use Fast technology for all of their search products going forward.
So fine buy Yahoo. My previous advice stands. In fact it becomes even more pressing – more complexity to unwind, more assets to regroup intelligently and spin off before they are completely absorbed in the giant corporate goo. That said, the numbers won’t look as good (except to the lucky Yahoo shareholders who have been bailed out.) But hey that’s what happens when you pay $45bn for $700mn of earnings and crummy operating cash flow. Which is of course what happens when you have money burning a hole in your proverbial corporate pocket because of a ridiculously under-leveraged capital structure…
One of the reasons I think the Microsoft situation is so interesting is that it is a particularly good metaphor for the “paradox of growth” facing many (most? all?) giant mega-corporations, including – and perhaps more relevant to many of this blog’s readership – the world’s financial services giants (banks, insurance companies, securities firms, exchanges, etc….) Citigroup may be the current poster child for this but this should be cold comfort for many of their peers and competitors. The single-minded pursuit of growth eventually always runs up against the law of large numbers. I figure it boils down to two fundamental limiting factors – diminishing returns on scale and exponentially increasing management complexity.
The optimal size (past which these limiting factors start reducing value faster than growth adds value) will of course be different by industry and activity and even by firm, but will exist all the same. Once this point is reached, it behooves management – and I would say especially the non-executives who are by definition supposed to be able to see the forest for the trees – to react and adjust accordingly. This could be by divestitures, de-mergers, recapitalisations, etc. Unfortunately for many reasons, the management of public large-cap companies typically are geared only to “go forward” and this type of behavior is too often an anathema. Indeed some of the great successes of private equity have imo been due to their ability to manage without concern for growing any line except the return-on-capital-employed line, and so to dispassionately dismantle overly complex and wrong-sized companies.
So should I buy Microsoft shares? If there was a chance that Bill & Co. would implement some variation or other on my suggestion, I would say yes. If they continue with business as usual? No way. Probably a reasonable short. Maybe the right position is short the underlying share and long OTM calls? Is this the right position to have in [fill in favorite large financial institution here] as well?
