The rumors of a possible $3.2 billion acquisition of Beats Electronics by Apple spread far and wide last week, and rightfully so. It wouldn’t just be the largest acquisition of all time for the 38-year old computer company — dwarfing the $429 million received by Steve Jobs’ NeXT in 1996 — but also the seventh billion- or near-billion-dollar “unicorn” acquisition by the major forces in consumer tech in just the last year (for those who need a reminder, these companies are WhatsApp and Oculus by Facebook, Waze and Nest Labs by Google, Nokia by Microsoft, and Tumblr by Yahoo).
To put that in perspective, there have only been eight billion-dollar acquisitions by these consumer companies in the last decade (all data in this analysis comes from CrunchBase and Wikipedia).
While news stories about these recent unicorn acquisitions have focused on the specifics of each deal, such as its financing, strategic premise, and chance for success, collectively, they usher in a radically different understanding about the future of the consumer technology business, and how startups and investors must adapt to this changing exit environment.
The Wide Gap Between Enterprise And Consumer M&A Is Closing
Even though enterprise acquisitions don’t get nearly as much popular press attention as those of more photogenic consumer startups, budget-buster M&A deals have traditionally been the almost exclusive domain of enterprise corporations over the past decade. Companies like EMC, Oracle, IBM, and Cisco regularly conduct multi-billion-dollar acquisitions across a whole range of product verticals. For instance, in the last decade, Cisco has completed seven unicorn acquisitions worth $25.2 billion, and Oracle has completed 10 unicorn acquisitions worth $42.9 billion.
Enterprise companies use an aggressive acquisitions strategy for myriad reasons, but one key element is their ability to rapidly grow acquired products using their existing sales channels. As companies targeting the enterprise space, these massive acquirers already have deep sales relationships across the Fortune 500 and even into medium-sized businesses. For startups, building these relationships in the enterprise is extraordinarily time consuming given the sales cycle typical of large clients. Thus, acquirers have an opportunity to purchase a market-tested product from a startup through an acquisition, and then immediately start selling it through their sales channels, hopefully increasing the sales growth of both the startup and the acquirer.
Apps like Tumblr, Instagram, and WhatsApp – while not currently integrated well with their parent companies’ core products – have the potential to act as a multiplier effect on their respective platforms.
Consumer companies never had the same ability to quickly grow their acquisitions through sales, and thus were hesitant to acquire new product lines. For this reason, many of Google’s largest transactions (YouTube an exception) were related to the advertising business, which is not only the revenue center of the company, but also the location where the sales leverage was highest in order to quickly begin growing the revenue of the new acquisition.
Now that companies like Apple, Google and Facebook have their own consumer platforms to grow products, this hesitation has disappeared. A possible Beats transaction makes sense, since Apple can sell the headphones in its own stores alongside its existing product lines. Nest made sense for Google, both because of its centrality in the home and also for the data the company could provide to its parent (note: Nest has said that it will not share its data outside of Nest). Apps like Tumblr, Instagram, and WhatsApp – while not currently integrated well with their parent companies’ core products – have the potential to act as a multiplier effect on their respective platforms.
The wide gap in the M&A culture of enterprise and consumer is closing, and I would expect to see more of these large transactions in the future.
Competition Matters Much Less Than Expected
It has been a truism that competition for a startup drives up its price in the marketplace. Whether it’s previous companies like Groupon or Twitter that have entertained multiple exit paths, or just supply and demand, investment bankers and advisers often emphasize the need to get multiple buyers into the process in order to sell at the maximum price.
While finding multiple buyers certainly helps, the current wave of unicorn acquisitions are intriguing because many of them had only a single interested acquirer, yet continued to command a high price in the market. Nest Labs comes to mind here. Google appeared to be the only company interested in the Nest’s device, a highly engineered and beautiful thermostat that is making a play in the Internet of things. Even though Tony Faddell was the former head of the iPod division at Apple, the acquisition never made sense for the computer company. The same argument can be made for Beats (not a likely Facebook or Yahoo purchase) as well as Nokia and Tumblr, which didn’t seem to have any other buyers in their processes.
The only two unicorn acquisitions in the last year that were competitive were Waze and WhatsApp. In the former case, Facebook was believed to be interested in the company, although speculation toward the end suggested that the company was not interested in opening an Israeli engineering office (however, the social network would proceed to do just that a few months later with its acquisition of Onavo). WhatsApp was engaged by Google for a lengthy time (the company has publicly stated it never made a formal offer), although it seemed that the founder Jan Koum was not interested in a deal with the search company.
For entrepreneurs and VCs, it can be frightening to have only a single exit option. However, these cases indicate that the cause for alarm should be a bit more muted than it has in the past.
Location and Tax Advantages Don’t Seem to Be Affecting the Prices
Analysts of tech acquisitions often discuss the tax implications of acquisitions headquartered overseas. The notion that companies are willing to pay a higher price for companies overseas is almost commonplace today among columnists, given the current U.S. policy toward corporate taxes. Revenue generated overseas is not taxed until the money is repatriated to the U.S., which has the effect of incentivizing companies to leave their funds overseas.
However, of the last seven unicorn transactions, only two have been located overseas – Waze in Israel and Nokia in Finland. Indeed, the only company on the list with deep interests overseas appears to be Microsoft, which also bought Luxembourg-headquartered Skype as well in 2011.
Companies care a lot more about the product, team, and growth of a startup than its location and tax implications when making a transaction.
Even more interesting is that the majority of these transactions happened outside of Silicon Valley. Only WhatsApp and Nest were located in Silicon Valley, with the others located in the Los Angeles area (Oculus and potentially Beats) and in New York City (Tumblr). This is not entirely different than the past, given that Google bought DoubleClick out of Boston, for instance, and Yahoo bought Overture from Burbank, California.
This small amount of data doesn’t definitively prove that tax advantages aren’t a factor in acquisitions. Smaller startups may benefit from an overseas effect, and for talent acquisitions, being headquartered near the acquirer is probably an advantage. But we should stop using this theory without qualification, since the available data shows that companies care a lot more about the product, team, and growth of a startup than its location and tax implications when making a transaction.
The Rise of Chinese and Asian Internet Companies Could Usher in Heavier M&A
One interesting dynamic to watch out for in the next few years is what effect the growing number of massive Asian Internet companies will have on the exit profiles of startups. Viber, the Cypress-headquartered calling and messaging app, was bought by Japan’s Rakuten for $900 million last year. The giant has the goal of becoming the world’s largest Internet services company, and thus, it would not be surprising to see it begin to acquire startups more aggressively. Another example is Samsung, which is believed to have at least a billion dollars set aside for technology acquisitions.
Then there are the Chinese Internet juggernauts, with Alibaba and its upcoming IPO being a prime example. With its newfound liquidity, the company could greatly expand its M&A if it were to begin expanding overseas. In addition, Tencent has invested in a number of companies in Silicon Valley such as Snapchat and Kamcord, and such actions could certainly be a dress rehearsal for more extensive M&A activities in the future. There is some haziness in this story, as the politics surrounding trade between the United States and China are complicated. Nonetheless, Chinese companies will eventually expand, and their impact will be felt in the startup exit market regardless of American policy.
Acquisitions Are Exciting, But There Is a Limit
There is no doubt that this is a hot time for technology companies. Even with sagging stock prices, companies like Apple and Google have incredibly large war chests to purchase what they want at almost any price, and they all have incredible access to additional capital on the bond markets, giving them even more financial flexibility.
However, all of this excitement can freeze up quite quickly if investors start to get skittish, and companies pause and wait for more macroeconomic stability. But that is the roller coaster experienced by startups in both good times and bad, and sometimes, the new dynamics of acquisitions can help you Beats the market.