Will Microsoft’s LinkedIn Purchase Pay Off?

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Will Microsoft’s LinkedIn Purchase Pay Off? by Knowledge@Wharton

Pinar Yildirim, Eric Bradlow and Peter Zaleski on Microsoft’s LinkedIn purchase

Microsoft’s planned acquisition of professional services network LinkedIn for $26.2 billion could pay off at several levels. For one, it would open potentially new revenue streams to shore up its maturing business portfolio. Two, Microsoft could use LinkedIn to find new ways to market its existing offerings like its Microsoft Office products, Skype and online learning platform Lynda.com. Three, it gives Microsoft a substantial presence in the social networking space that it has coveted for long. LinkedIn has 433 million members, with 60% of them on mobile platforms, according to a Microsoft press note announcing the acquisition.

LinkedIn would also gain with bigger opportunities to market its offerings that have eluded it thus far. With Microsoft on its side, it would probably have the muscle to thwart any attempts Facebook may make in encroaching into its territory. Experts say the challenge now facing Microsoft is to monetize the opportunities LinkedIn brings and make the acquisition price seem justified.

The Future Workplace

“I see Microsoft creating the future workplace,” said Wharton management professor Pinar Yildirim. “[Microsoft CEO Satya] Nadella is envisioning a future platform where an employee comes to work and uses a variety of products – creating documents, presentations, being able to communicate with other individuals within and outside their company, and have the information on the business background of the professionals they might talk to.”

The planned merger is “a good move,” according to Peter Zaleski, chair of the department of economics at Villanova University. “Typically, I don’t like mergers between two unrelated companies … but there are some synergies here that can be exploited,” he said. “Microsoft has a strong presence in the markets for software, browsers and operating systems, and LinkedIn would be another offering it could capitalize on.” He described the deal as a “win-win,” adding that the early beneficiaries would be LinkedIn shareholders.

Yildirim and Zaleski discussed the business logic driving Microsoft’s acquisition of LinkedIn on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. Listen to the podcast at the top of this page.

“LinkedIn data provides a great source for a targeting engine for Microsoft products and services.” Eric Bradlow

According to Wharton professor of marketing, statistics and education Eric Bradlow, the deal allows Microsoft, which is primarily a software company, the opportunity of becoming a content company. Bradlow is also co-director of the Wharton Customer Analytics Initiative.

“LinkedIn, through user-generated profiles, is one of the world’s most important companies for person-to-person connectivity, for companies searching for talent, and for individuals looking to expand their own personal [network],” Bradlow said. “When this now gets synergistically combined with Microsoft’s assets, there is the potential to provide even greater services to individuals.”

Under the terms of the deal, LinkedIn would operate as an independent company within the Microsoft fold. “This may make some sense in the short term, but in the long term I see the research done by both firms as being synergistic and definitely the data as being synergistic,” said Bradlow. “That is, LinkedIn data provides a great data source for a targeting engine for Microsoft products and services.”

A Growing, Profitable Network

Yildirim noted that Microsoft has been trying to acquire a social network for a while, including an unsuccessful attempt about a decade ago to go after Facebook. With LinkedIn, Microsoft gets a company with growing revenues that is also profitable, she said. LinkedIn posted $2.99 billion in revenues in 2015, a 35% increase over that of the previous year, and an EBITDA (earnings before interest, tax, depreciation and amortization) of $780 million. At the net level, however, LinkedIn has consistently posted losses. In 2015, its net losses were $166 million, up sharply from $15.7 million in 2014.

There are bright spots to LinkedIn’s finances. Its premium services bring in revenues over and above the advertising income it earns. That business model sets it apart from other social networks like Facebook, which rely mainly or solely on advertising revenues, said Yildirim. Its revenues from premium subscriptions in 2015 grew 22% over that of 2014 to $532 million.

More revenue could be unleashed, according to Zaleski. He said LinkedIn has failed to monetize all the value-added features it offers, while Microsoft has “historically done a good job” at monetizing its offerings. “Microsoft may be able to do it for them,” he added.

More Strength to Existing Products

As businesses get more and more global, the database LinkedIn brings would be “tremendously useful” for Microsoft, Yildirim said. It would make Microsoft Outlook, for example, a stronger product. LinkedIn would boost Microsoft Outlook by providing users background information about the people they may want to email, or updates on what their professional contacts are working on, she noted.

“[Microsoft is] at the top of its growth curve.” –Peter Yaleski

With LinkedIn, Microsoft could also strengthen its other products like Skype, said Yildirim. “Skype has many users, but Microsoft hasn’t been able to take much advantage of it,” she pointed out. “Businesses are increasingly relying on long-distance communication, and the Skype offering could benefit from LinkedIn’s networks.”

Skype faces competition from Facebook in its video offering, but the former will likely prevail, according to Yildirim. However, Microsoft’s “real core” is about serving businesses as opposed to individuals, which is Facebook’s forte, she said. Skype would score with its features like screen-sharing and teleconferencing, she added. “The problem with Skype is that it is user-unfriendly, somewhat cumbersome, and hasn’t evolved over the years,” she noted. “These types of acquisitions would only allow these products to grow.”

The Right Price?

Media reports have questioned the price Microsoft is paying for LinkedIn. Between February 2015 and February 2016, LinkedIn’s share price fell from $270 to $100, recovering to $131 last week. It has since risen to $196 this week, the price Microsoft will pay for each LinkedIn share, representing a 50% premium over the previous week’s close.

Zaleski didn’t think Microsoft overpaid for LinkedIn. LinkedIn’s value had been depressed and Microsoft saw opportunities to boost that, he said. Yildirim noted that LinkedIn’s stock price decline reflects projections of weaker growth in its user base. She didn’t find that surprising: As social networks grow bigger, their growth rates decline, she said.

Yildirim, however, saw the timing of the LinkedIn deal as right for Microsoft, which “has been struggling” as a mature business. Zaleski agreed, and said Microsoft is “at the top of its growth curve,” and could use LinkedIn to accelerate its fortunes.

From LinkedIn’s perspective, the evolution from a startup mode towards becoming a more mature company calls for significant investments, said Yildirim. LinkedIn would be able to tap into the knowledge and product base of Microsoft as it seeks to expand its business, she added.

Challenges Ahead

Microsoft has had a “poor track record with big deals,” according to an article in The Economist. It cited Microsoft’s purchase of Skype in 2011 for $8.5 billion as “no runaway success,” and other deals including the 2007 purchase of online advertising firm aQuantive for $6.3 billion and the $7.2 billion acquisition of Nokia’s handset business in 2014. Microsoft’s acquisitions over the past five years have “for the most part flopped,” Zaleski noted.

“These types of acquisitions would only allow these products to grow.” –Pinar Yildirim

According to Zaleski, Nadella leads a fairly mature company with decreasing growth prospects. His main focus area would be allocation of capital, and if its investment horizons are shrinking, the top goal would be to protect shareholder interests, he said. At the same time, the firm would keep an eye out for profitable investment opportunities, he added.

Yildirim said Nadella is “sitting on a tough chair, leading a mature company.” However, she saw him as emerging successful in moving more and more of the company’s business to the cloud. The LinkedIn acquisition would pay off in the years ahead, she predicted.

The road ahead for Microsoft and LinkedIn potentially has other challenges, too. Yildirim said one of the threats LinkedIn has faced is the prospect of Facebook getting into its space. “There is nothing that prevents Facebook from creating a suite where employees and employers could connect, not just in their professional communications but also in other, social ways.”

According to Zaleski, LinkedIn has had the first-mover advantage in the professional networking space. “Probably, LinkedIn’s presence made it tougher for Facebook to enter that market,” he said. “Yes, Facebook could enter that market, but the fact that LinkedIn did it first made people think of Facebook as more social [and] LinkedIn as more professional.”

Microsoft & LinkedIn

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