Deal or No Deal? The psychology of making deals

Google shelled out $3.1 Billion in cash for DoubleClick. A few weeks ago Cisco paid $3.2 Billion for WebEx. Warren Buffett built Berkshire Hathaway by acquiring companies, and amassed the second largest personal fortune in the world. The popular TV game show "Deal or No Deal" provides some insight into the psychology of making deals; emotion versus logic, and fear versus greed. The same psychology plays out in corporate deals. Closing a deal is easy, making it pay off is hard.

Corporate acquisitions certainly involve strategy, financial analysis, competitive assessment, build versus buy questions, and lots of "due diligence" exercises. After all of that is done it still comes down to a few key executives making a "gut level" decision on price. The strategies can line up and all the answers can come back "yes" but in the end someone has to decide how much to pay. A deal can make strategic sense, but at some point it doesn't make financial sense. In most cases the real results are not known until five or ten years after the deal is done.

The Short Term. The analysts and pundits give instant analysis and prognostications. Interesting but usually myopically focused on the details. Here is something to ponder. Cisco could have acquired WebEx four years ago when the stock market valued Web-Ex at $600 Million. Why did Cisco wait four years and pay $3.2 billion? DoubleClick was a publicly traded company two years ago and valued at less than $1 billion. Anyone could have acquired  DoubleClick, but a private equity firm took them private less than two years ago for $1.1 billion. They later sold off two divisions for $525 million. Yesterday Google paid $3.1 billion for what remained of DoubleClick. Why did Google wait two years and pay billions more? Did Cisco and Google make the right financial decisions? It depends on how they leverage the technologies and the decisions they make over the next five years. They could turn out to be reasonable deals.

The Long Term. Some deals make sense immediately, but most deals take years to play out. The true value of deals hinges on what you can do with them once they are part of your company, not what they are doing today. Leverage and synergy is what makes a  $100M acquisition today worth a billion five years later. Small acquisitions ($50M to $100M) are easier to integrate, easier to leverage and find synergy, and carry less risk if they fail. Everything is harder with a billion dollar acquisition. All the same logic and opportunities are there for big deals and sometimes they pay off, but there is a long history failures. It is just a matter of scale. See my earlier post "The top 10 worst billion dollar acquisitions of all time".

Deal or No Deal? The popular TV show starts with 26 briefcases, all with a dollar amount between $1 to $1M inside. The contestant picks one briefcase as their own and then proceeds to open the remaining cases. As the amounts are revealed they are asked to accept a deal to walk away without going further. They start by opening 6 cases. After they are opened a "banker" looks at the amounts already opened and off the table, and calculates the odds on all the remaining cases, and offers an average amount to the contestant. Almost invariably the contestant gets greedy, refuses the deal, and takes their chances on opening four more cases. More amounts are revealed and the bankers offer goes up or down based on the remaining amounts in play. The banker works on logic and probabilities. The contestant is usually working on emotion and competitive spirit.

Warren Buffett is logical...and he has made more money investing and acquiring companies than anyone else in the world. Big acquisitions make headlines but rarely payback on the bottom line. Warren Buffett made his money on boring businesses like insurance, manufacturing, retailing, consumer products. He never over pays for acquisitions and has a lot of patience for making his acquisitions pay off.

Which approach is right? They both work if you stick to your strategy and don't violate your own rules. Acquisition deals get very competitive. Emotions run high. Decisions must be made quickly with incomplete information. Even the best executives sometimes succumb to emotion, competitive spirit, and ego in high pressure situations. That is when they over pay and make mistakes.

Poker players bluff...competitors do too. I have watched poker tournaments where players are faced with tough decisions. They aren't sure what their opponent is trying to do, or what cards they hold. The good players have already established rules for what to do in these situations. They write them down to remind themselves so that emotions don't cloud their judgment. Warren Buffett never wavers. He may pass on a deal now and then but he rarely makes a mistake. Business executives would be wise to do the same.

Entrepreneurs face some of the same tough decisions. Should you take VC money now or wait for a better valuation? Should you accept an acquisition offer or go it alone for another year or two? Should you invest the time and money in a new product or improve what you already have? Should you hire that high priced executive or grow an internal employee? These decisions are every bit as strategic and difficult as the billion dollar acquisition decisions. It is just a matter of scale. The difference is that big companies can make huge mistakes and not even feel the pain. Startups make life or death decisions every day. One big mistake and they are dead. That is a big difference.

At the end of the day a start-up entrepreneur and a Fortune 500 CEO are very much alike. They both make tough decisions and rely on gut level instincts. The difference is that the results of these decisions are felt instantly in a startup and aren't know until 5 or 10 years later in a big company.

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Comments

[Steve Morsa]

Don, I'd guess that it wasn't Microsoft's (at least initial) intent to do so, but it looks like you guys may have come up with a great way to induce media-darling Google to waste sizable chunks of their free cash on overpriced properties...just be sure they "find out" that you (and/or the other Internet big boys) are actively pursuing a company...

Sure; DoubleClick's a nice company to own...but at 10x annual gross revenue?

I don't think so.

Applying your point about acquisition sizes...for the same 3.1 billion, Microsoft could/can buy...31 100 million dollar "something elses"...or 50-100+ 10-50 mill dollar ones...what makes more sense?

No reason to wait to add this to your list of top 10 worst billion dollar acquisitions ever. The passage of time won't change a thing on this coorporate boondoggle....

No deal, Howie. No deal.

[Ola]

Good post, but I thought you were going to come out and tell us why you think Microsoft was outbid by Google. Microsoft has more cash but have consistently been outbid by Google. Is Google more interested in fending off Microsoft than Microsoft is in even becoming a major player in the game?

[BlogReader]

Why did Google wait two years and pay billions more?

Microsoft was also in the running for DoubleClick, I'm guessing their offer was in the same ballpark. Why?

[Ian Smith]

Don,

The fundamental issue here is that the guys who make these decisions do not get hurt when the bubble bursts. This is just another rush of irrational exeburence and proof that markets do not have memories.

For all of its weaknesses and bureaucracy Microsoft isn't going to be put out of business by a bubble player such as Google. When the recession comes, anyone focused exclusively on superficial and discretionary consumer spending is going to hurt badly. And Google is, for sure, massively exposed to this risk.

[Alberto Saavedra]

When I read that Google outbidded Microsoft, I thought that Microsoft wasn't really serious about competing in online advertising but when I analyzed the price I understood the reason, there's no way DoubleClick is worth more than $3.1 billion for Microsoft.

As Don states we will only know the impact of this acquisition in the following years, but I don't think Googlers are happy with the price paid. Sure they have the potential to make it pay but Google wasn't interested in DoubleClick 2 years ago and if it wasn't for Microsoft they probably wouldn't have acquire DC either.

It all depends now on Microsoft's next move, when behavioral targeting was introduced ValueClick, aQuantive and Tribal Fusion were mentioned as possible acquisitions to increase reach (no one mentioned DoubleClick); the market will be expecting Microsoft's reaction and it has to be logical not emotional.

[Andrew]

Impressive article. Well written. I may have to include this as one of the best articles I have ever read.

[mindmarc]

>> Why did Google wait two years and pay billions more?

Because Google is expensive itself (now worth $145B!) and can use that market cap to make expensive purchases.

[pat ross]

Love the show of deal or no deal.try to watch all the shows I was just wandering do you ever pick someone from south carolina to go on the show,I sure would love to be on the show,love to try to win some money.someone that needed it.I cry when people win. I think the show is great and thanks for the people that started this show deal or no deal.Good luck to everyone. GOD BLESS YOU ALL.

[deals2spot]

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