Acquisitions are being announced every day now. CBS, the TV network, will acquire Last.fm, the streaming music service. eBay, the auction company is buying StumbleUpon, a social bookmarking service. A while ago eBay bought Skype, a free VoIP telephone service.
Acquisitions are usually about synergy, market share, cost savings, leverage, or strategic moves into new markets. Hmmm...what will CBS do with Last.fm? And what will eBay do with StumbleUpon? The synergy isn't obvious to me now, but acquisition strategies play out over many years.
My good friend Ashkan Karbasfrooshan over at HipMojo wrote a brilliant piece today on the music business and acquisitions in that space. Ash suggested that Apple should acquire one of the major music labels. His analysis of the traditional music business versus the online music business was interesting. But, his financial analysis of the stock market implications of such a merger really made me stop and think. Think about this excerpt from the HipMojo post;
How Much Would Owning the Music Add to Apple’s Bottom Line?
Say the percentage of WMG (Warner Music Group) and indie songs sold is actually 25% (and not 33%), that represents 500M songs, which at $1 would help retain $500M in profits for Apple...Using the example above where a company buys the indies and smallest major record label for about $3B would add $500M in profits, which would in turn add 500M x 35 P/E = $17.5B in market value for Apple
So, if Ash's estimates are correct, Apple could buy Warner Music for $3B and the stock market would immediately reward Apple with an additional $17.5B in market cap. Now that is a deal that would make an investment banker smile.
Companies with high Price/Earnings ratios should buy companies with lower P/E ratios. From a financial point of view this makes obvious sense. However, most acquisitions are not done with financial engineering in mind. They are done for strategic reasons. And usually the tables are reversed. The big companies with lots of cash and low P/Es are acquiring the small hyper-growth companies with astronomical P/Es.
Music, television, and radio companies have low P/E ratios and stock market caps compared to technology companies. Entertainment content is mashing up with technology as digital distribution of music and video move to the Internet. We have seen this coming for a long time. Steve Case saw it when he merged AOL with Time Warner. It was the classic high P/E technology company acquiring the low P/E content company. It was too early in the evolution and the synergies didn't materialize.
Maybe the time is now right for traditional content companies to merge with technology companies. CBS and Last.fm may be the first of many such mergers.