Microsoft’s move to purchase LinkedIn for $26.2 billion—the largest company-for-company acquisition in the technology industry since Hewlett Packard’s 2002 purchase of Compaq—is bringing out the predictable talk of irrational exuberance. But if the deal does indicate a bubble, it’s not necessarily in tech or in stocks.
First, the combination actually makes sense on many levels. The companies both cater to older, corporate users, and have similar missions, with Microsoft seeking “to enable people and businesses throughout the world to realize their full potential,” and LinkedIn “to connect the world’s professionals to make them more productive and successful.” Putting the two together could allow for some significant cost savings: Microsoft could economize a lot simply by imposing some discipline on LinkedIn’s profligate use of stock-based compensation, which the social-networking company has forecast at about $580 million in 2016, on revenues of between $3.65 and $3.7 billion.
Second, this isn’t a typical stock-market-bubble deal. In such transactions, a company with an inflated stock price issues equity to fund the purchase of another company with an inflated stock price, often driving the prices of both companies higher on some kind of ‘1 + 1 = 3’ logic. Microsoft, by contrast, is paying for the deal in cash. The stock market, for its part, has initially reacted pessimistically: Microsoft’s market valuation has fallen more than LinkedIn’s has risen, leaving the combined entity worth less than the individual companies were on Friday.
For a better sense of where the bubble might be, consider how Microsoft is raising the cash to fund the deal. The money will come entirely from new bond issues, adding about $25 billion to a debt load that has already increased by about $15 billion over the past year:
Corporate debt issuance has surged since the 2008 financial crisis for a variety of reasons, including central banks’ easy-money policies, low or negative interest rates in much of the developed world and foreign central banks’ more recent moves to purchase corporate bonds directly. In the US, corporate bonds outstanding amounted to 27% of gross domestic product as of March 2016, up from 20% at the end of 2007:
To be sure, some of the debt issuance is a form of tax arbitrage: instead of incurring tax liabilities by bringing in cash from abroad to pay for stock buybacks, US tech and pharmaceutical companies are instead borrowing the money at home. That said, when a source of funding is too cheap it will be abused, and excess issuance is generally a big danger sign, whether it involves tech IPOs in the late 1990s, mortgage debt in the middle 2000s, energy debt in the early 2010s or corporate debt today. Bloomberg