Link(ed)In the dots

linkedin-and-microsoft-logosLast week Microsoft announced its intention to buy LinkedIn for a total consideration of $26bn. This is a big move, even bigger than the $22bn acquisition of Whatsapp by Facebook in 2014. The reason why I did not write earlier about it is that I was trying to understand the move. After a week thinking about it, I just cannot.


Well, for LinkedIn’s shareholders, the deal is hard to refuse: LinkedIn’s share price has been suffering since the beginning of the year as the market has become increasingly sceptical about the social network’s sustainable future growth rate. Worse, fundamental shortcomings have become more numerous and obvious: low user engagement (less than 25% of users connect more than once a month), unclear purpose (from networking the firm entered business news and professional education), struggling profitability (despite $3.2bn in sales, the company reported a negative net income of -$170m last year) penalised by low ad revenues (6 times lower than the ones generated by Facebook in the US) and a raising dependence on professional services as opposed to individuals (‘talent solutions’ now account for c.65% of the firm’s revenues, which will soon have a hard time justifying its ‘social network’ primary status). Microsoft’s offer, at a 50% premium over the pre-announcement share price, represents a godsend in that respect.

LinkedIn's share price evolution since 01/01/2016. Source: Yahoo Finance
LinkedIn’s share price evolution (in USD) since 01/01/2016. Source: Yahoo Finance

AAEAAQAAAAAAAAOIAAAAJGQzMGIwMWJmLTJlYjUtNDE2OC04YmE2LTkzZDJkNzJhZDhmMgTo justify this high price, Microsoft mentioned the competitive tension generated by the presence of Salesforce. One can never predict in advance how well an integration will work and to which extent synergies would have been delivered, but such a merger would have made more sense: the two firms serve the same purpose – i.e. connecting professionals, either individuals, marketers, recruiters or headhunters, in order to create business opportunities – and LinkedIn already integrates Salesforce’s Sales Navigator product. To close the loop, Microsoft made a $55bn offer for Salesforce last year, which was perceived as too low by the target’s Board of Directors.

In terms of valuation, LinkedIn’s forward PE ratio is one of the largest of the ‘web 2.0’ industry, only second to Yahoo! in the sample chosen below. This fact was true even before Microsoft made a move towards the ailing social network. Unfortunately, a forward PE ratio in the 40x+ area is a sign of perceived overvaluation, even for a tech firm – former holders of Yahoo! shares may not disagree on that one.

Price / Forward Earnings Benchmark using various LinkedIn share prices. Sources: CapitalIQ, Author analysis
Price / Forward Earnings Benchmark using various LinkedIn share prices. Sources: CapitalIQ, Author analysis

This deal is also haunted by Microsoft’s appalling track record in handling and integrating large acquisitions. Experts obviously have in mind the disastrous acquisition Microsoft did in 2014 when it acquired Nokia’s Devices and Services’ business for $7.3bn before writing-off almost the entirety of the acquisition assets less than 18 months later. At best, the Redmond firm managed to maintain a ‘status quo’, as it has done with Skype since 2011 – and questions about the rationale were already present at the time. As a consequence, Microsoft’s share price reacted negatively following the announcement – only a 2.6% drop, which nevertheless still represents $10.5bn of lost shareholder value.

Jeff Weiner
Jeff Weiner: a happy man

So why such an unexpected alliance? In terms of synergies, the pitch is not obvious either. Jeff Weiner, LinkedIn’s CEO, mentions in his email to staff that the deal will “massively [scale] the reach and engagement of LinkedIn by using the network to power the social and identity of Microsoft’s ecosystem of over one billion customers”. Not sure what that means beyond having Outlook download data from LinkedIn to give you information on people you will meet. More generally, and contrary to what the Financial Times may think, I doubt that Microsoft’s products, which are targeted at enhancing the work efficiency within organisations, will be able to gain much insight from LinkedIn’s vast amount of outside-in data.

Alternative hypothesis: is Microsoft betting on internal corporate networks? In-house social networks are indeed becoming increasingly trendy. Even McKinsey believes that social tools will help reshape the way businesses work in a number of ways – see chart below. But internal social networks struggle to gain momentum and more importantly LinkedIn is not one of those. Indeed, the tool is well designed to search for individuals working for a particular firm, but it is unable to tell you how the firm is internally structured.

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Social tools carry a Prévert-style inventory of benefits

Another possibility is that Microsoft is trying to add content on top of its software offer. Social networks now represent the primary source of information for more than half of all online news consumers, and this trend comes with interesting ad revenues prospects attached. But LinkedIn is trailing Facebook or Youtube in that respect.

For me, the move was launched primarily to manage market perception. Microsoft is currently sitting on more than $100bn of cash & equivalents. This war chest cannot sit unused within the company for ever. There are only 3 solutions to that conundrum. One, Microsoft could pay hefty dividends as Apple did. The issue is that it would admit (as already highlighted on this blog) that Microsoft is running out of worthwhile investment opportunities. This is fine when you are Apple and sitting on hit products such as the iPhone, but much more worrying when you are Microsoft and holding onto an ageing operating system. Two, Microsoft could buy back some of its shares but this move would be uselessly expensive given that Microsoft’s shares trade near all-time highs. Three, Microsoft could pretend it is moving full steam ahead towards cloud computing, artificial intelligence and professional networking by making acquisitions. This is the path Satya Nadella and his team have chosen, a path similar to the one Marissa Mayer unsuccessfully led Yahoo! to, but targets in the space are scarce and, as the saying goes, “anything scarce should become expensive”. To make the bill more palatable, the acquisition is partly financed through debt which, given Microsoft’s AAA rating, represents a net cost savings – the tax shield amount more than largely offsetting the incremental debt interest costs.


Although spectacular by its size, this acquisition strategy is not unique. Tech behemoths ‘of the past’ see that, after more than a decade of steady and healthy cash flows, the new wave of innovators, led by Facebook, Google and a tribe of unicorns, can in the relatively short-term jeopardise their business model. To fight against the new entrants, they cannot rely on their in-house innovation skills, which have aged together with the rest of the organisation. In a (final?) burst, they are now spreading their cash, hoping they will manage to integrate the right engines for future growth – think about Blackberry and its push in cybersecurity for instance. Massive war chests, overvalued (tech) stocks, cheap debt, ageing organisations: the perfect recipe for disaster and value destruction, sadly.


The 5 economic trends that worry me (1/2)

Normal-Rockwell-Boy-on-High-DiveMany experts agree to say that the current economic environment is something we have never witnessed before. Despite negative interest rates – $10tn in total, now including some high-quality corporate securities – global growth is expected to remain limited – only 2.4% forecast in 2016 according to the latest World Bank report – as well as inflation – for 2016 the OECD forecasts 0.06% in France, 0.43% for Great Britain and 1.07% for the USA despite encouraging unemployment figures. This environment makes the hunt for growth significantly more challenging than in the past and has thus favoured the emergence of behaviours that, taken together, may well threaten the stability of the economy in the medium-term. Although the reader may find many more, I have taken 5 examples which have particularly struck me over the last few months.


  1. Stock markets reaching all-time highs despite weak macro indicators

The weak growth prospects expressed in my introduction have not deterred investors from massively buying stocks. Last week the S&P500 reached a level only 0.5% below its all-time high, lifted by a slight recovery in oil prices and the increased likelihood of a Fed Reserve rate ‘status-quo’ in June. This has come on top of the second longest bull run in the S&P’s history – the longest lasted from 1987 to 2000. And yet it is difficult to identify the ‘hard facts’ that investors base their bullish assessment on.

theres-a-new-most-bearish-strategist-on-wall-street“If you look at U.S. stocks on a global perspective, to be touching or near that high is pretty phenomenal. “Yet when we look forward, we’re struggling to find that next source of growth. Maybe the drag has passed, but where is the growth going to come from?” (Gina Martin Adams, Wells Fargo Securities LLC)

As Benjamin Graham, the famous value investor, claims in his book The Intelligent Investor, we may have switched from an investment strategy, where people believe in the true intrinsic capabilities of the firm they invest in, to a speculative strategy, where people believe that they will be able to sell their shares to someone who puts a higher valuation on them, irrespective of the company’s performance. The former is characteristic of a potential bubble.


2. Unicorns and unicorpses: party like it is 2000

the-18-billion-london-tech-unicorn-thats-struggling-to-pay-its-staff-is-worried-about-going-bustFor those unaware, ‘unicorns’ are companies which have managed to raise equity with an implied valuation exceeding $1bn. Not so long ago, the ‘unicorn’ club was made of a handful of companies with (i) proven business models, (ii) established profitability and (iii) huge opportunities for global growth. Today, the ‘club’ has grown to 150 members or so, all of which cannot claim to tick the three boxes mentioned above.

First, entrepreneurs have realised that being labelled a ‘unicorn’ could turn out to be a real marketing tool and business booster. Some of them decided to enter through the service door by actually raising a relatively limited amount of equity (let us say in the single-digit millions) for an even smaller share of the capital (let us say 0.1%). As a consequence, the firm manages to qualify for the ‘unicorn’ label, even if clearly no investor would be willing to pay close to $1bn for the entirety of the company.

Furthermore, to make up for the lack of revenues, entrepreneurs have come back to the non financial-related KPIs made famous in the late 1990s to support what ended up being the ‘dot-com bubble’: number of users, number of clicks, number of hours of videos uploaded on website etc. Growth is not about top line or EBITDA anymore as taught in corporate finance classes but measured by the notion of ‘increased engagement’ and ‘scale’ instead. Spotify, for example, managed to raise equity last year based on a $8.4bn valuation despite not having made a profit yet. This is easier than in the 2000s given that, as rightly pointed out by Terence Fung, the new ‘Web 2.0’ is mainly about B2C applications rather than B2B software which contributed to the ‘dot-com’ firms’ reputation.

20150210005716!Slack_IconFinally, some startups benefit from potentially inflated growth prospects. Slack has managed to raise $200m of equity based on a $3.6bn valuation in April. The company is nonetheless far from shaking the industry at the moment. It offers a simple chat app and is currently used by 2.7m daily active workplace users, only 800k of which are paying at present. Each paying customer is therefore implicitly valued at $4,500.

2015 witnessed soaring unicorn valuations but 2016 and 2017 may bring those valuations down to earth, a forecast trend that has given birth to the term ‘Unicorpse.

[To be continued on Thursday…]

Warren hopes there are seeds in the Apple

6a00d83473f9dc69e20148c6ac7b95970cAfter decades of cautious suspicion towards technology-related stocks (with the notable exception of IBM), Warren Buffett has crossed the Rubicon and is now an Apple shareholder. The news clearly took the financial community by surprise: Apple’s stock jumped by 2% in pre-market trading after the announcement (indicated by a green arrow in the chart below) and is now up 4% compared with last week.

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Mr. Buffett cannot be described as a 'geek'. Credits: CNN.
Mr. Buffett cannot be described as a ‘geek’. Credits: CNN.

Not only does the move surprise given Mr. Buffett’s historical ‘tech-adverse’ inclination  but this move also contradicts a statement he made no earlier than 4 years ago, saying that he would “not be able to value [Apple’s] stocks“. Last but not least, Berkshire is investing at a time when another famous investor, Carl Icahn, has taken the opposite direction by offloading his $4bn stake last month.

Why has Warren turned round? We cannot accuse Berkshire of trying to benefit from the recent air pocket Apple went through which we discussed on this blog three weeks ago, since the stake was built throughout the first quarter. Nor can we assume that Mr. Buffett will be able to impose his views on Apple’s management: his stake is important in nominal terms ($1bn), but only represents 0.2% of the total shareholder structure.


In my view, the reason lies in another factor we have underlined. According to our EV/EBITDA benchmarks (reproduced below) the market is primarily viewing Apple as a hardware company at present, which is understandable given the share of revenues generated by devices such as the iPhone and, to a lesser extent, the iPad and the iPod.

EV/EBITDA benchmarks.
EV/EBITDA benchmarks as of 28 April 2016. Sources: CapitalIQ, author analysis

And yet, Apple is trying hard to get out of the generally slow-growing, low-margin hardware trap where it can be considered as an alien – but for how long? – by investing part of its massive war chest into promising ventures, both internally – iTunes and, more recently, iCloud – and externally – the $1bn stake taken in Chinese ride-hailing app Didi Chuxing is the most significant to date.

Warren-Buffett-laughingIf Apple manages to grow the seeds it has been planting over the last few years and to convince Wall Street that it has now become a credible player in the ‘virtual’ space alongside other tech behemoths such as Google, Amazon or Microsoft, it will be able to command a higher valuation multiple which will ultimately lift its stock price. And the ‘Oracle of Omaha’ will have won his bet (once more).

‘Irrational Exuberance’ striking again?

Prof. Robert Shiller
Prof. Robert Shiller

I thought today’s economic environment was perfect to reread Irrational Exuberance, the book written by Nobel Prize-winning Yale University professor Robert Shiller. Prof. Shiller made himself known to the general public by predicting the ‘dot-com’ bubble in the 2000s as well as the housing market collapse in 2007-2008. Coincidentally, no later than last year Prof. Shiller granted us with a third revised edition of his book which analyses the two aforementioned events to identify behavioural patterns leading to market instabilities.

Chapter Four, ‘Precipitating Factors: The Internet, the Capitalist Explosion, and Other Events‘, lists and discusses the triggering factors that were specific to the economic context at that time. The section entitled ‘Twelve Precipitating Factors That Propelled the Late Stages of the Millennium Boom, 1982–2000‘ resonates way too well in the light of the rise of ‘disruptive’ technologies and social media. Below are some quotes which I found particularly striking.

Because of the vivid and immediate personal impression the Internet makes, people find it plausible to assume that it also has great economic importance. It is much easier to imagine the consequences of advances in this technology than the consequences of, say, improved shipbuilding technology or new developments in materials science. [...] It could not have been the Internet that caused the growth in profits: the fledgling Internet companies were not making much of a profit yet. But the occurrence of profit growth coincident with the appearance of a new technology as dramatic as the Internet created an impression among the general public that the two events were somehow connected.

Do not get me wrong: some of the largest technology companies (by market capitalisation) completely justify their valuation because of the value they create. Nonetheless, one cannot help but think that some of the technology-related ventures created over the last couple of years (with a special attention to loss-making ‘unicorns’) were lifted by the abundance of liquidity in the market and the investors’ search for yield in a depressed environment.

New technology will always affect the market, but should it really raise the value of existing companies, given that those existing companies do not have a monopoly on the new technology? Should the advent of the Internet have raised the valuation of the Dow — which at the time contained no Internet stocks?

The impact of social media and ‘Uberisation’ still remains to be quantified, as the impact of the Internet was in the early 2000s. But here again caution is paramount. As an example, asset-light Fintech companies were expected to put the traditional banks out of business. We now see that those companies have benefited from an extremely favourable credit environment and struggle as soon as the tailwinds fade.

What matters for a stock market boom is not, however, the reality of the Internet revolution, which is hard to quantify, but rather the public impressions that the revolution has created. Public reaction is influenced by the intuitive plausibility of Internet lore, and this plausibility is ultimately influenced by the ease with which examples or arguments come to mind. If we are regularly spending time on the Internet, then these examples will come to mind very easily.

This sentence is very applicable to today’s trend. A vast majority of the successful emerging companies target the B2C market and actually very often make the ‘B’ closer to the ‘C’ by ousting intermediaries – think about Uber or Deliveroo. The change has settled in our everyday life, which makes the examples even easier to remember.

Anticipation of possible future capital gains tax cuts can have a favorable impact on the stock market, even when tax rates actually remain unchanged. From 1994 to 1997, investors were widely advised to hold on to their long-term capital gains, not to realize them, until after the capital gains tax cut.

Calls for a fiscal stimulus as a way to reinforce the already-implemented monetary ‘quantitative easing’ have been growing. Although in the UK the next budget will only affect the corporate tax rate, investors are right to believe that the fiscal burden may loosen soon on capital gains as well.

Although there is no doubt at least some truth to these theories of the Baby Boom’s effects on the stock market, it may be public perceptions of the Baby Boom and its presumed effects that were most responsible for the surge in the market.

Structural drivers such as demographics are indeed among the most popular discussion topics when it comes to predict the outlook of both the stock and the housing markets. Prof. Shiller nonetheless warns us that our (sometimes) self-fulfilling anticipations and expectations may actually be stronger than the real effect.

As further evidence that the media growth was boosting the stock market, we now know that after the peak in the market in 2000, business reporting took a major hit in reaction to declining public interest. Hip business magazines like Red Herring, the Industry Standard, and others went out of business.

As sole writer of this blog I have to plead guilty. As many other media, I have probably paid a disproportionate amount of interest to the evolution, past and future, of the housing market.

In a non-experimental setting, where people’s focus of attention is not controlled by an experimenter, the increased frequency of price observations may tend to increase the demand for stocks by attracting attention to them. [...] The rise of gambling institutions, and the increased frequency of actual gambling, had potentially important effects on our culture and on changed attitudes toward risk taking in other areas, such as investing in the stock market.

Our environment, including social media conversations, provides us with many opportunities to be part of the stock market ‘game’ and many platforms have leveraged the parallel with gambling, making their platforms increasingly entertaining.

In a survey of home buyers in 2004, Karl Case and I asked: “Do you worry that your (or your household’s) ability to earn as much income in future years as you expect might be in danger because of changes in the economy (someone in China competing for your job, a computer replacing your job, etc.)?” Nearly half of our 442 respondents (48%) said they were worried. Some of them said that one motivation for buying their house was the sense of security that home ownership provides in the face of the other insecurities. [...] One might call this a “life preservers on the Titanic theory.” When passengers on a ship think the vessel is in danger of sinking, a life preserver, a table, or anything that floats may suddenly become extremely valuable, and not because these assets have changed their physical attributes. Similarly, at a time when people are worried about the sustainability of their labor income, and there are not enough really good investment opportunities, they may tend to bid up prices of all manner of existing long-term assets in their efforts to save for the dangerous lean years seen ahead. They may not manage to save more in real terms. They may hold such assets even if they now believe the assets are overpriced and in danger of losing value in the future.

The sense of geopolitical and economic insecurity remains persistent – today a poll revealed that 86% of French people believed that the situation “had not improved for the French population in general”. In that context individuals tend to rely on ‘safe’ investments such as real estate and bonds, despite the very poor returns offered by the latter.

Sans titreWill we witness another 2000-type market crash in the short-term? I do not believe so. However, I do think that the Central Banks’ decision to open the liquidity tap to an extent never been witnessed before has led investors, i.e. the general public, to increasingly disconnect their thinking from the real fundamentals of our economy. The way the two converge again will tell us whether we are heading towards a ‘soft landing’ or a ‘bubble burst’.

Rotten Apple? On innovation and deflation


Apple reported on Tuesday a decrease in quarterly sales for the first time since 2003. The trend in itself was less surprising than its magnitude – revenues dropped by 13% on a YoY basis and, more importantly, fell short of analysts’ estimates. CEO Tim Cook used a bunch of arguments to justify the unexpected underperformance – blaming in turn a strong dollar, difficult economic conditions especially in APAC and difficult “comparisons for iPhone sales” – but could not prevent Apple’s share price from dropping by 8% right after the announcement and is now trading 7% below its pre-announcement level. All equity analysts have revised their target share price downwards and most of them believe that $120 a share is now a realistic long-term value, which only gives a 24% upside to existing shareholders. The Financial Times has even dared to state that “Apple [was now] living in the shadow of its own past success”. After more than a decade of impressive performance, is the love story between the firm and Wall Street coming to an end?

$48bn of shareholder value vanished overnight. Source: Yahoo Finance
$48bn of shareholder value vanished overnight. Source: Yahoo Finance

What is irrefutable is that the market is increasingly realising that Apple will likely remain a one-product shop in the foreseeable future. Growth in ancillary products and services can be perceived as impressive – 30% and 20% YoY respectively – but the iPhone still generates almost two thirds of Apple’s revenues. And when this core engine starts coughing earlier than expected, as it did over the last quarter – 50.4m iPhones shipped over the quarter vs. 51.2m forecast by analysts, down 16% YoY, with an average sales price (ASP) of $641 vs. $658 anticipated – the full firm wobbles.

Split of Apple's Q2 revenues by product. Sources: 8-K report, author analysis
Split of Apple’s Q2 revenues by product. Sources: 8-K report, author analysis

This slowdown could nonetheless have been anticipated. Since 2012, Apple has launched at least a new iPhone model every year in September in an attempt to boost not only its sales volume, but also its ASP as older models became increasingly cheap. This helped the firm create maintain a decent ASP until the next model was launched – a usual pattern in tech: innovation is the best way to fight deflation. Depending on the price point chosen for the new model, the mix between volume and ASP uplift varies – for instance, as the chart below shows, the iPhone 5 was a ‘volume’ hit whereas the iPhone 6 and 6+ primarily lifted the ASP. The issue is that the iPhone 6S and 6S+, launched in September last year, did not manage to achieve any of those two objectives. Analysts blame the extending renewal cycle as a root cause. This is possible. What is certain though is that the ‘boost’ last year was much shorter-lived and the landing is more severe than it was over the previous years. Q3 (ending in June) is expected to bring no improvement, especially on the ASP front, given that Apple just launched the iPhone SE, priced at $400 in order to further penetrate emerging markets.

Quarter-on-quarter evolution of iPhone volume sold and ASP. Sources: Apple 8-K reports, author analysis

Using EV/LTM EBITDA and EV/FWD EBITDA valuation multiple benchmarks to adjust for differences in capital structure, Apple now sits in the same ballpark as many high-tech hardware manufacturers such as IBM, Intel or HP, trailing true ‘software developers’ such as Facebook and Google – a gap that kept widening since Facebook announced brilliant results for the same period. This means two things. First, as previously written, Apple is still largely perceived as a hardware company and it will take time for the markets to believe in the services as a real growth pillar. Second, the market believes that, with an installed base of 500 million iPhones and more than 1 billion Apple device users worldwide, Apple’s golden growth era is now behind and that we should not expect similar the future to be a replica of the past. In the manner of the world’s largest banks which have become ‘too big to fail’, high-tech behemoths are now ‘too big to soar’.

EV/EBITDA benchmarks as of 28 April 2016. Sources: CapitalIQ, author analysis

Apple also made a couple of surprising announcement with regards to its financing structure that left analysts even more circumspect. The firm indeed decided to expand its share buyback program from $140bn to $175bn and to increase its quarterly dividend will be increased by 10%. The company is still sitting on more than $230bn of cash and equivalents and this redistribution program should not impede its acquisition firepower if need be. Nonetheless, Apple has been returning increasing amounts of cash to shareholders since 2012 and this cannot be interpreted as a good signal if you remember one of my earlier posts. The firm uses buybacks and dividends to support its share price by implicitly believing that any incremental project it could invest in would not generate any better return than the one shareholders would get elsewhere on the market. With the S&P 500 down 1% over the last 365 days and interest rates at an all-time low, Apple states loud and clear that there are not many growth levers available on the market at a decent price right now.

So, is there any hope? Yes. First, Apple still benefits from a strong brand image and high customer loyalty, which enables it to command a price premium while limiting the risk of massive and sudden ‘customer exodus’. The launch of the iPhone 7 later this year will be a real make-or-break since analysts, as well as the general public, have been waiting for the ‘next big thing’ for too long. apple-icloud-logo1Second, Apple made its entry in the services arena early enough to establish a significant position, primarily through iTunes and, to a lesser extent, iCloud. If it manages to keep a competitive advantage against Amazon, Google and al., Apple will not only be able to maintain a strong financial performance but also get closer in terms of market perception to the real ‘software disrupters’. In the meantime, Wall Street is granting the company the ‘benefit of the doubt’: hard for them to change sides and burn the idol that they used to venerate.

Whatever happens in the future, this is a perfect illustration of the race between innovation and deflation that has been shaking high-tech companies for decades; you need to keep running to stand still. If you stop innovating significantly enough so that your products are not perceived as clearly ahead of the technology curve, you face a huge risk of ‘commoditisation’ and dilution into a very competitive and agile market. Microsoft and Nokia will not disagree.

P.S.: The full Earnings Call presentation and podcast are available on Apple’s website.