A couple of months ago, rumors of some serious acquisitions shocked the tech world. Every one had an opinion, had an analysis, or some crystal ball to predict what the outcomes of these acquisitions would be. We’ll look at two of them today. One deal fell through, while the other was completed. One was praised, the other scrutinized. Both were orchestrated by large household names. Both were for $3 billion, but only one made sense.
The first one we’ll examine is the offer Facebook made for Snapchat. To be honest, I’ve never used Snapchat, so some could argue that my critique may be biased because I “don’t understand” it. I’ll concede that I don’t know the potential of this company, and no one truly does, but I’d like to think I have a fairly good grasp of how businesses can add value to their company by acquiring other companies. I’ll get off my high horse and get back to the article.
Snapchat is a an app that allows users to share content with other users for a limited time before the content is deleted forever. How does this company add value to Facebook? The company has about 26 million active users that share a lot of content each day. Snapchat also has a lot of active teenage users, a demographic Facebook seems to be interested in engaging. Snapchat could add value through it’s user base, through its code, and maybe even “cool factor”. The acquisition could show Wall Street that Facebook is actively seeking to stay relevant an on the cusp of new technology in order to avoid the fate many other social networking sites have suffered. However, the deal was declined by Snapchat, which was actually better for Facebook.
The bottom line is that Snapchat doesn’t generate any income. It isn’t monetized, so Facebook would have to find a way to monetize it, if that was what they were planning to do. Facebook wouldn’t be investing in another income stream but in a user base and relevance. Most of the reactions to the deal were of shock that Snapchat would decline such an offer. Others felt Snapchat made the right choice in declining the offer, saying the company was actually worth more than three billion. Silicon Valley and Wall Street have interesting ways of valuing companies, but I definitely don’t think Snapchat is anywhere near $3 billion.
The value of a business is the present value of its future cash flows. It would be very very difficult to gauge what the future cash flows of Snapchat would be, especially since there aren’t any current cash flows. I personally wouldn’t even buy the app, and yes, I know its a free app. Facebook makes the majority of its money through advertising. Putting adds on Snapchat would seem counterintuitive to the way Snapchat was created. Facebook could use some of the info it collects from users to make their presentations better to other companies that use Facebook or Instagram ads. I just don’t think that more info and data mining is worth $3 billion. Maybe I just don’t understand Snapchat.
Looking at Facebook’s financials, we see that Facebook had about $8 billion in revenue, $1.5 billion in net income and $11.45 billion in cash. This $3 billion acquisition would be a huge one in relation to the amount of business Facebook is doing, and would have been completed by exchanging Facebook shares for Snapchat. I simply don’t see the justification for paying this incredible amount for a company that isn’t profitable and doesn’t seem to add value.
Let’s take a look at the highly talked about, and highly scrutinized, Apple and Beats by Dre deal. In full disclosure, I do have a strong bias towards Apple. I have an iPhone, using a Mac to right this article, and I have it as a stock in my portfolio. But I can admit that Apple has been a little lack luster without the magnificent Steve Jobs, has seemed to be copying other companies instead of being innovative and needs to do some more when it comes to revolutionizing the way we engage technology. With that being said lets take a look at Beats and see if there is any value to this company.
Beats makes headphones that have the endorsement of many celebrities, athletes and entertainers. They have dominated the $2 billion headphone market with about 30% marketshare since they started in 2008. They also have a music streaming service with a monthly subscription. We see immediately that Beats is actually generating income through two income streams and has the “cool factor” that seems to be more important than anything else. But how could Apple possibly increase their value by buying Beats?
I think a lot of people have forgotten that Apple created iTunes, has been selling products such as computers, iPhones, and iPods that all use headphones. In fact, Apple has already changed their iPhone so that you would only listen to music with Beats headphones. Apple could still collect revenue from the sale of headphones, music service subscription, and beef up their own Genius software on iTunes. I’m not saying every Apple user is going to buy Beats headphones, but it isn’t as if Beats is going to suddenly stop selling headphones after the acquisition. To me, Apple has an easier job of integrating Beats into their core business and would continue to generate the revenue that Beats has been generating.
Looking at Apple’s financial statements, we see that they had $170 billion in revenue, $37 billion in net income, and $146 billion in cash. Compared to all the business Apple is doing, this $3 billion acquisition is pretty small. I just don’t understand why this acquisition saw so much backlash. Was it too practical of a move for Apple? Did it need more flair and style points?
I don’t think either company is worth $3 billion, but I do think Apple made a better acquisition that added value to their core business. If there is anything we could learn from Apple it is this: we should add businesses to our portfolio only when they add value to our overall investment philosophy, not only on their “cool factor”.
Disclosure: I am Long AAPL