Monday, September 9, 2013

Tale of two Transactions: Microsoft and Timken

Two very different transactions were announced this week. Microsoft (MS) announced the acquisition of Nokia’s (NK) mobile phone business and related patents Acquisition.  See Ralph’s post for additional insight. MS stock dropped 4.5% for a market value decline of $11B which exceeded the $7.2B purchase price. Timken (TK) agreed to spin-off its steel division after being pressured by shareholders Spin-off. Unlike MS, the market reaction was positive with its shares jumping 9%. Although different in size and industries, both companies faced the same problem; namely, how to best remedy lagging operating and stock price performance. They chose different paths with different initial shareholder value results. Examining these differences may offer some insight into how firms facing this issue can best respond.

 MS purchase appears “cheap” at 0.35% of NK’s revenues compared to comparable transactions selling at 0.77%+ . Nonetheless NK’s business position was weakening and generated large losses. Thus, it seemed more like a rescue to protect MS’s mobile strategy. NK and MS operated under an arrangement whereby NK’s phone would operate using MS’s software system. This collaborative effort had a 3.7% market share in a market dominated by Apple and others. Combining two midgets is unlikely to create a giant. Furthermore, it will probably take considerable additional MS investments to improve the situation. Their ability to gain share against established competitors is likely to be expensive as well. This probably what underlies the large negative response from MS’s shareholders. An additional reason is investor concern about increasing MS’s exposure to the more volatile consumer device market compared to its more stable and profitable corporate business.

Keep in mind as well, that the transaction is proposed by the outgoing CEO Steve Ballmer. When his “retirement” was announced MS’s stock jumped 7%-not exactly an endorsement of his management skills. It appears that Ballmer and MS, who missed the smart phone revolution, are trying to claw their way back-aka fighting the last war. This may be in response to shareholder concerns over MS’s restructuring efforts. Less costly alternatives such as shareholder distributions, break-up via spin-off of its various divisions or waiting for the new CEO to be chosen should have been considered.

TK was suffering from a lagging share price. It tried to justify retaining the steel division based on diversification and synergy reasons before finally agreeing with shareholder activists to spin it off. The significant share price increase upon that announcement reflects shareholder belief in the benefits from increased focus. This includes reduced overhead and improved investment allocation decisions. See Subtraction for a more complete restructuring alternatives discussion. TK’s current CEO, who resisted the spin-off, will retire once the transaction closes.

The transactions represent two very different responses to a similar problem. Initial market response suggests making the empire smaller through a spin-off can make citizen shareholders wealthier compared to an acquisition. Of course, this is not always the case. It does, however, suggest a deeper consideration of management strategy and its value implications before embarking on acquisitions.

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