One can understand why investors take a dim view of Microsoft Corp.’s bid for Yahoo Inc. The software giant has struggled to crack the online advertising market and overpaid for deals in the past. Adding scale could theoretically raise margins, but it could also result in massive indigestion. Shareholders, banking on the latter scenario, have wiped $41 billion (Rs1.6 trillion) off of Microsoft’s market value. This looks too pessimistic.
Tech stocks have admittedly had a poor week—the Philadelphia Semiconductor Index, a proxy for the sector, has fallen 3% since last Friday’s bid. But Microsoft’s shares have plummeted 14%.
This may partly reflect the fact that investors expect Microsoft will need to sweeten its offer to seal the deal. Yet, even if Microsoft boosts its bid by 10%, that will only account for some $4 billion of the wiped-out value.
It appears Microsoft’s shareholders are convinced Microsoft will fail to integrate the business effectively and will destroy most of the value of Yahoo’s businesses—or a huge chunk of its own existing operations. True, this would be the biggest takeover ever for Microsoft, and boss Steve Ballmer already looks stretched managing the sprawling empire. The market may also think competitor Google Inc. will snaffle up more market share while Microsoft is internally consumed by the deal.
But what if investors are wrong? Microsoft thinks it can find $1 billion in synergies. This could be a stretch—and the group won’t break out what portion of these come from cost cuts, which investors value more highly than promises of enhanced revenues. But assuming it can achieve these, they would have a net present value of about $7 billion. If it raises its bid by 10%, as the market expects, the premium it offers will total about $18 billion. Subtract the value of the synergies from the premium and it looks like the deal destroys about $11 billion of value—$30 billion less than the market has wiped off Microsoft’s value.
Sure, these are just approximations. And the market may be right: Academic studies suggest mergers tend to destroy more value than they create, so there’s a statistical chance this one will, too. But the reaction has been so negative that anything short of complete disaster would prove a pleasant surprise to Microsoft shareholders.
Happy birthday, credit crunch
It’s been precisely one year since HSBC Holdings Plc. and New Century Financial Corp. revealed mounting subprime mortgage problems. There had been warning signs before. But 8 February 2008 is an apt anniversary for the start of the credit crunch.
Remember those heady days? Private equity firms ruled the mergers and acquisitions business, funding their deals with big dollops of ever-cheaper debt. Hedge funds lapped up loans and other assets as fast as Wall Street could crank them out.
For a time the US home loan woes almost seemed containable. After all, no more than 3% of investment banks’ revenues came from subprime mortgages. So, the LBO (leveraged buy-out) gravy train steamed on, culminating in the announcement of the $48.5 billion (Rs1.9 trillion at the current exchange rate) takeover of Canadian telecoms firm BCE Inc., the biggest ever, at the end of June. But as mortgage defaults skyrocketed, it became apparent that the pain would be more widespread—thanks largely to collateralized debt obligation managers’ and investors’ voracious appetites and the ability of subprime mortgage bond derivatives to feed them.
The blowback has been severe. LBOs have ground to a halt. Hedge funds are having a much harder time financing trades. All manner of investment funds from Massachusetts to Australia to Norway have been hit. Banks have recorded more than $130 billion of losses. And the crisis has undermined trust in mainstays of the credit system including ratings agencies, bond insurers and the short-term commercial paper market.
More confusion probably lies ahead as the pain seeps into other consumer lending sectors such as car loans and credit cards. And responses by the industry and government alike have so far been piecemeal and of varying success. Overcoming the worst credit crisis in 20 years is going to take time. But that’s no reason not to hope for better news by its second anniversary. Anthony Currie