Commentary on Political Economy

Monday, 3 August 2020

Microsoft May Test the Faith With TikTok

A deal could stretch Microsoft’s renewed credibility in deals and business execution

Under the leadership of Satya Nadella, Microsoft has picked up its deal-making pace while also being more judicious about major outlays. PHOTO: ANUSHREE FADNAVIS/REUTERS
The backdrop for Microsoft’s MSFT +4.25% interest in TikTok couldn’t be more favorable. But the software giant still has a lot on the line if it ends up winning the hand of the upstart social network.
It helps that it is a bit of a shotgun wedding. President Trump and his officials have been threatening to shut the U.S. portion of the Chinese-owned service down over national-security concerns. That has forced TikTok parent Bytedance to seek an eligible buyer. It is a small pool: Bytedance’s investors reportedly value TikTok at around $50 billion, and Microsoft’s big tech peers are also now under intense government scrutiny themselves.
The outcome remains unclear. After a weekend of mixed signals from the Trump administration, Microsoft said Sunday it will continue discussions, with a target of wrapping up a deal for the U.S. operations by Sept. 15. But making haste may be wiser. Noting that India’s ban of TikTok in June sent both creators and users flocking to other services, Mark Moerdler of Bernstein said in a note Monday that TikTok’s value could decrease quickly if a deal isn’t reached soon. The competition isn’t sitting still; The Wall Street Journal reported last week that Facebook has been offering financial incentives to big TikTok stars to lure them over its Instagram platform.
If and when the deal is done, Microsoft will have to make a convincing case to its investors on why this won’t mimic past ill-fated forays into consumer tech. The acquisitions of Skype and Nokia’s NOK +5.96% mobile-device business stand out as high-price flubs, as does Microsoft’s quixotic attempt to buy Yahoo in 2008. That deal was only stymied by the resistance of Yahoo’s owners who—it turns out foolishly—rejected Microsoft’s $45 billion offer as insufficient. Yahoo was sold eight years later to Verizon VZ -0.40% for about one-tenth that price.
It helps Microsoft that all those deals were done under past management. Since Satya Nadella took over as chief executive in early 2014, the company has picked up its deal-making pace while also being more judicious about major outlays. According to data from FactSet, Microsoft has averaged nearly 13 deals a year since then, but only four have exceeded the $1 billion mark, compared with seven in the 10 years before. The biggest have been the $26 billion acquisition of LinkedIn in 2016 and the $7.5 billion pickup of GitHub in 2018. Both have largely been considered smart moves by a company whose overall sound execution has increased its market value more than fivefold over that period to its current $1.6 trillion level. LinkedIn is now a key part of Microsoft’s growing commercial cloud bundle of services—a crucial part of the company’s appeal to investors.
An opportunistic grab of TikTok could further that solid record—or tarnish it. TikTok expects to generate $1 billion in revenue this year and to hit $6 billion next year, according to internal targets reported by the Journal. But the company is still believed to be losing money and possibly burning cash, as peer Snap Inc. is still doing with double the current revenue base. That could put a weight on Microsoft’s bottom line—just after the company reported its highest fiscal-year operating margin in eight years.
And even under a forced sale—with President Trump talking down the price—buying TikTok could easily exceed Microsoft’s record outlay for LinkedIn. Noting Monday that the deal could bring Microsoft “an attractive, high-growth business,” Walter Pritchard of Citigroup added that “we see a stretch on the strategic rationale as a mild negative” at a time when Microsoft faces little controversy relative to its big tech peers. Bernstein’s Mr. Moerdler also added that he is very surprised Microsoft is considering such a deal well outside its core business.
The new Microsoft has earned a line of credit with investors. TikTok may end up tapping it.

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