Microsoft – LinkedIn Deal: An Applied Analysis of Transaction Game Theory
In June 2016, Microsoft announced that it would acquire LinkedIn for $26.2 billion in an all cash transaction. The union of these two companies represents one of the largest acquisitions of the year and presents a number of interesting considerations around the potential synergies between the two companies. As background, Microsoft is a leading technology company that focuses on transforming the way people interact with software products and resources. It operates across several key product lines, including cloud services, business processes and products and personal computing. LinkedIn, alternatively, focuses on developing and connecting the world’s largest professional network. When LinkedIn’s board of directors was approached with the winning bid of $196 per share, they unanimously approved the bid as fair. While it is not difficult to see why most shareholders would be happy with the premium paid above its current trading price, the interesting part of the transaction arises from the individual player dynamics that ultimately lead to the announcement price.
The merger / acquisition process for two companies is kicked off when the bidding company submits a proposal for the price it is willing to pay to acquire the other company. The target company then reviews the details of the offer and returns to the bidder with its decision, typically declining or accepting. Given that both management teams are required to act on behalf of the shareholders of the firm, they will invariably seek to maximize the value (whether that is the lowest price as the bidder or the highest price as the acquirer) they can get for their company. The really interesting part of the process is created by the fact that one company’s decision heavily influenced by their expectations of the other company’s actions. That is, the companies generally do not make decisions in isolation.
Taken in context here, Microsoft presumably wanted to submit the lowest bid possible in order to acquire the target. LinkedIn, however, had the exact opposite motives and instead wanted to procure the highest bid possible in order for it to sell (given certain limitations). This created a unique situation during the bargaining period where the two companies will use their own assumptions about the target company as well as their expectations of the other player’s assumptions to determine a fair price for purchase. If Microsoft submitted a low proposal, it would be able to extract the greatest value for the investment but there would be a large risk that LinkedIn would decline. Given that Microsoft could pay more than this initial, low proposal, it would be made better off by offering a higher proposal that increased the likelihood LinkedIn would accept. LinkedIn experienced a similar set of payoffs. While it sought to get the highest price for its shareholders, it also realized that there was a threshold at which point any offer above it would be fair and beneficial for its shareholders. Here, LinkedIn had to determine whether the potential to get a higher value exceeded the risk that Microsoft walked away from the deal and its shareholders would be left with nothing.
If managing the numbers between these two players did not seem complex enough, another twist in the process was created through the competitive bidding process. During negotiations, it was rumored that Salesforce, among others, was also in the bidding process with Microsoft. This added another level of complexity to the game because now Microsoft had two players’ actions that it had to account for when determining its own willingness to pay in the process. Microsoft not only had to pay enough to satisfy LinkedIn but also had to pay enough to defeat Salesforce. In this scenario, we see something more similar to an auction, specifically, an ascending bid auction. The bidders for LinkedIn will generally submit their initial offers in a staggered manner and the target then reviews them. According to game theory, under an ascending bid process we would expect the bidders to submit proposals up until they reach their value. This is the dominant strategy for each of the players in the game. We see something somewhat similar to that here. After Salesforce submitted its bid for LinkedIn, Microsoft upped its bid in order to be more competitive in the process, realizing that it did value the company more than its original proposal. Due to sharp deadlines and other considerations that go into the merger process (form of consideration, relationships, etc.), the dominant strategy outcome is not always reached though.
As was eventually decided, Microsoft won the bid war. Although it did not offer the highest value, the all cash form of consideration was enough to offset the disparity in price. In the future, it will be interesting to see how well Microsoft can integrate the professional network into its product offerings in order to justify the 50% premium it paid on LinkedIn’s closing stock price the previous Friday. Alas, while game theory may help us understand the factors in proposing an offer value, it will not tell us whether the ultimate offer value and corresponding synergies will be realizable and beneficial in the long-run.
Sources:
- WSJ Article: http://www.wsj.com/articles/microsoft-to-acquire-linkedin-in-deal-valued-at-26-2-billion-1465821523
- Bloomberg: http://www.bloomberg.com/news/articles/2016-07-01/other-bidder-pushed-microsoft-to-raise-linkedin-bid-before-deal
- Merger Proxy Statement: https://www.bamsec.com/filing/104746916014430?cik=1271024
- Microsoft 10k: http://apps.shareholder.com/sec/viewerContent.aspx?companyid=MSFT&docid=11509606
- LinkedIn 10K: http://d1lge852tjjqow.cloudfront.net/CIK-0001271024/bba69558-09d5-4fbf-9221-e8902c1b6937.pdf?noexit=true