So many news and blog articles covering/trashing Microsoft's $26B all-cash acquisition of LinkedIn. Yet among those that I read I didn't see any M&A analysis on the market reaction. So here's the simple version for your reference.
We're going to try to answer two questions:
- Is value created in this deal?
- What about synergy?
Is value created in this deal?
This is relatively simple. We only need to see the changes in the market cap for MSFT and LNKD to understand how the market saw this on the 1st trading day post-announcement (June 13th, 2016):
- MSFT: –$10.2B
- LNKD: +$7.9B
The net result is –$2.3B, meaning that the market believed that there's roughly $2.3B value destroyed in this deal.
To see how $2.3B decrease factor into this, we should compare the number to the pre-announcement Enterprise Value (EV) of LNKD.
LNKD's closing market cap of last Friday (June 10th, 2016) was $16.8B. On its Q1 balance sheet it has about $3.1B in equivalent cash and $1.1B in long-term debts. The enterprise value is therefore:
- EV = $16.8B + ($1.1B – $3.1B) = $14.8B
Therefore, the $2.3B loss in value represents 15.5% of LNKD's EV.
Basically if we assume the deal has zero impact, neither negative nor positive, on MSFT's core business, the deal basically destroyed 15.5% of LNKD's value.
But how could this be? The two companies are complimentary in product lines and there are many obvious cross-sales opportunities. The businesses could only be better together with lots of synergy. How could 1+1 be smaller than 2?
What about synergy?
LNKD last year made an EBITDA of $266M. Prior to the announcement, the market was valuing it at:
- EV/EBITDA = $14.8B / $266M = 55.6X
In addition, MSFT is paying a multiple of:
- EV/EBITDA = [ $26.2B + ($1.1B – $3.1B) ] / $266M = 90.9X
Whether it's market valuing at 55.6X or MSFT paying 90.9X, LNKD has to continue to be a high-growth business to justify for such high multiples. But LNKD is already a 400M-user/100M-MAU business. For it to grow at high double digits, the employees have to be highly motivated and energized to achieve the unthinkable so as to justify the high multiples.
And since this is an all-cash deal, employees' vested shares will be cashed out all at once – and many of them will be cutting IRS a huge check next Spring – and all unvested RSUs and options will be converted into those of MSFT's.
It's very hard to be inspired by this future enough to achieve the unthinkable, compared to when the shares were still a hot professional social network company.
It is therefore reasonable to think that the previously projected high growths by Wall Street have to be adjusted. And the drop in value in this deal probably reflects that.
This is not to say that there is no synergy in this deal. Quite the contrary.
The operating assets, i.e. current businesses, from MSFT and LNKD are definitely highly complementary. The assets themselves in the hands of seasoned corporate managers would be more valuable than being separate.
However, the market simply had too high an expectation on LNKD prior to the announcement, probably driven by high expectation on the highly motivated LNKD employees. Now that the dream part is taken away, the modeling might have to fall back to more traditional (boring) corporate projection that doesn't factor much into the human part – "everyone can be replaced" – and therefore the drop in value.
Conclusion: you could have high potential synergy in M&A but a drop in value nonetheless. Buy/sell shares based on synergy at your own risk.