The Microsoft-LinkedIn deal this week conferred some much needed mercy on funds this quarter, if they owned LinkedIn (LNKD, Financial) stock.
Oakmark Funds, for instance, had such a sharp uptick in its return June 13, the day Microsoft announced its plan to acquire LinkedIn, it sent a note to clients to explain. Its stake in LinkedIn was a surprise to investors because the firm started the position in the second quarter before the SEC-required disclosure date. The stock’s spike to $196 the day of the announcement from $131 the day prior gave an unusually quick profit for the long-term focused fund.
Oakmark, which is led by gurus Bill Nygren (Trades, Portfolio) and David Herro (Trades, Portfolio), said they noticed the stock’s fall from $250 in the fourth quarter to less than $100 in February, becoming inexpensive compared to their estimate of intrinsic value.
In its note to clients, Oakmark said “We believed that margins for LinkedIn’s core employment services business were higher than peer group margins. However, LinkedIn was heavily investing in several early-stage opportunities in adjacent businesses, which drastically reduced reported earnings. If we were right, then we purchased LinkedIn’s rapidly growing core business below the market P/E and got the other investments for free. The price Microsoft is paying is consistent with our thesis.”
Relatively few other investors tracked by GuruFocus had or meaningfully increased holdings in LinkedIn. Frank Sands (Trades, Portfolio), CEO of the outperforming Sands Capital Management, held the biggest position with 5.5% of outstanding shares, equivalent to 2.5% of his portfolio. Sands had increased the position by 11% in the first quarter, when the share price averaged $148.
Second to Sands is Spiros Segalas (Trades, Portfolio), manager of the $1.8 billion Harbor Capital Appreciation Fund, who owned 1.7% of shares at 1.9% of his portfolio at first quarter-end and increased the position by 15.8% during the quarter.
Paul Tudor Jones (Trades, Portfolio) increased his position the most in the first quarter, by 1814.6%, but it only grew to 79,494 shares equal to 0.23% of his portfolio. No other gurus owned more than a million shares or 0.5% of outstanding shares.
Microsoft has stepped up acquisitions since CEO Satya Nadella took the helm in February 2014. Acquired companies increased 127% from 2014-2015 compared to the prior two years. They have also come from a range of fields. Microsoft has purchased companies focused on field service management, sales “gamification,” machine learning, organizational productivity, datacenter and cloud management, and gaming, to name a few. In the third quarter, Windows and Devices were the only two groups to decline among all segments.
Nadella appears to be expanding outside its largest segment, “More Personal Computing,” which grew revenue 1% in the three months and fell 7% for the nine months ended March 31. Within that segment, Windows revenue fell 7% for both periods, driven by lower patent licensing revenues and PC sales. Devices revenue declined 11% and 31% for the two periods, driven by lower phone sales, which dropped 54% for the nine months.
The company founded by Bill Gates (Trades, Portfolio) has a history of growth, with five-year growth rates of 9.5% for revenue, 1.2% for EBITDA, 2.2% for free cash flow and 14.5% for book value.
LinkedIn was its biggest to date. Microsoft paid $26.2 billion for the professional networking site in an all-cash transaction, paying just 25% of its cash on hand, which has grown each year since 2007, and roughly 5.5 times book value.
Nadella discussed his philosophy for acquisitions in a note to Microsoft employees regarding LinkedIn (reported by PC World):
“To start, I consider if an asset will expand our opportunity – specifically, does it expand our total addressable market? Is this asset riding secular usage and technology trends? And does this asset align with our core business and overall sense of purpose? The answer to all of those questions with LinkedIn is squarely yes.”
He also said he expected the combination of LinkedIn’s public network and Office 265 and Dynamics to “make it possible for new experiences such as a LinkedIn newsfeed that serves up articles based on the project you are working on and Office suggesting an expert to connect with via LinkedIn to help with a task you are trying to complete.” New opportunities will also “be created for monetization through individual and organization subscriptions and target advertising.”
Under his plan, LinkedIn will continue to operate independently while partnering with Microsoft on projects to integrate its capabilities with Office 365 and Dynamics.
LinkedIn has had exceptional revenue growth since 2009 but has fallen into net losses for the past two years, with ever-shrinking net margins. In the past year, its stock price had dropped almost 40%.
More than 50 gurus own Microsoft, and it remains to be see whether the LinkedIn acquisition will change their thesis when second-quarter portfolio come out.
The market did not immediately warm to Microsoft’s deal, with its shares declining 2.7% on June 13 and remaining relatively flat at $50.39 at close Thursday. Microsoft has a P/E ratio of 39.98 and P/B ratio of 5.3. Both its price and P/E are near 10-year highs.
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