Investing Ideas

The more i think about Microsoft’s new business model the more I like it.

• Customers win because they buy items cheaper. A 2-3% saving is as good as what you get from a cashback rewards card.
• Advertisers win because they are guaranteed to make money. No more click fraud. No more paying for clicks without converting to sales.
• Microsoft wins because they could increase search market share. Im not sure how successful this will be but it will have at least some impact on Microsoft’s share of the search market.

 Disclosure: I own shares of Microsoft

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Click here for my initial analysis of the Yahoo buyout by Microsoft

With Yahoo rejecting Microsoft’s initial offer the ball is in Microsoft’s court. The letter from Ballmer seems to suggest that if the $31 bid is rejected that MSFT will go to Yahoo shareholders. I still think this deal can be done at a price between $35-$38. Microsoft could easily sell off the non-core assets of Yahoo to pay for the increase, Will it? As a Microsoft shareholder, I hope not. There are no other buyers for Yahoo and existing shareholders will push for a sale to get the 62% premium.

Should Microsoft Wait?
Some people have suggested that Microsoft can take the offer off the table. They can then buy Yahoo cheaper in a year’s time. The problem is with Google holding 56% market share and increasing market share every quarter there is very little time left. The proposed buyout will take 2-3 quarters just for Regulatory approval, add in another year to integrate Yahoo and MSN. If they wait for a year before they try to buyout Yahoo cheaper, then its almost 3 years that Google will have to improve and consolidate its lead. If Google reaches 70-75% market share the Search/Text Ads battle is over. The only thing that could break Google’s domination with 75% market share would be a revolutionary search engine that provides dramatically better results than Google.

Is Search the complete story?
While everyone focuses on search and text ad’s and Google’s lead in that market. There is something most overlook, the banner displays and rich content ads. Yahoo holds a big lead over Google in the Banner Ads. Microsoft could use Yahoo to build a big lead over Google in the banner Ad’s market. Microsoft may feel they can use the Aquantive platform to boost revenue from Yahoo sites faster than most people think. Microsoft may also be interested in the mobile platform Yahoo has developed. Their interest in the mobile ad platform seems obvious with todays purchase of Danger.

Disclosure: I own shares of Microsoft

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To read Microhoo - Round 2 the follow up to this article click here
The Offer
Microsoft has offered to buyout Yahoo for 44.6 Billion. The Yahoo shareholders can choose either cash or 0.9509 shares of Microsoft, a 62% premium to the closing price of Yahoo of 19.18 on Jan 31 2008.

Why Microsoft wants yahoo

• Microsoft gets a world class internet franchise. Yahoo is the biggest portal on the web and the site with the highest number of views, about 500 million per month.
• 16.7 Billion in cash and assets. Yahoo has a lot of hidden assets that no one considers in their valuation like Yahoo Japan, Alibaba, Gmarket. A recent motley fool article by Rick Aristotle Munarriz calculated the value of these assets at 14.3 Billion + cash equivalents of 2.4 Billion.
• 1.33 Billion in recent acquisitions In the last year it bought Zimbra for 350 Million, Blue Lithium for 300 Million, Right Media for 680 Million.
• Yahoo also owns del.icio.us, Flickr, Konfabulator, Overture aka Yahoo Search Marketing (Yahoo paid 1.6 Billion in 2003), Hotjobs. Pulling a number out of my hat I’d say these are worth at least 2 Billion.

The price Microsoft is paying is not as exorbitant as it seems. The total value of cash and assets Microsoft receives is about 20 Billion. So in effect Microsoft is buying out Yahoo’s core portal+mail+search+messenger business for 24.6 Billion.

Microsoft’s MSN and Yahoo have a lot of businesses in common. Their portals provide news, finance, entertainment, search and maps. Microsoft and Yahoo also overlap on webmail and messenger services. A merger will bring about significant savings by removing redundant infrastructure and operating costs. The combined entity would have enough market share so that it can compete with Google. The press release says that Microsoft expects to generate 1 Billion in synergies for the combined entity. Currently Yahoo’s profit is 660 Million, MSN’s loss is about 250 Million, and synergies are 1 Billion. Microsoft can earn 1.4 Billion per year on an investment of 24.6 Billion, the merged unit has an effective P/E of 17.5.

How it affects Yahoo
Yahoo is steadily losing market share not only to Google but also to Microsoft. It would be great if Yahoo could merge with Google. Yahoo would provide the content and Google would provide the technology for search and advertising. Unfortunately since Google has a 56% share of the search marketplace the chance that a merger will be approved is zero. It has been mentioned that Yahoo could outsource the search and advertising to Google for an instant increase in earnings but that would mean giving up of the search and advertising market. Any partnership with Google would mean that Microsoft will not go through with the buyout and the share price would collapse and bring on shareholder lawsuits. There are few companies big enough to buy Yahoo and no other company that has the synergies to make the a buyout offer above 45 billion.

Yahoo was trading at $34 per share recently but had dropped below $20 when the offer was made. The 62% premium is difficult to turn down. The most that Yahoo can do is to get a better price from Microsoft, say in the $35-$38 range.

How it affects Google
Google cant buy Yahoo because it already has a dominant position in search. What Google can do is to make it difficult for the buyout to go through. Yahoo and Microsoft are the leaders in Portals, Messenger and Webmail. A delay in the buyout and any problems in integrating the companies would give time for increase its lead in search. If Yahoo accepts the buyout, the best Google can do is use any confusion and uncertainty during the integration process to increase its lead. The approval for the buyout would take months and the integration of MSN and Yahoo would take longer. If Google manages to get to 75% of the market share before a successful MSN+Yahoo integration they win the search battle.

A new proposal
In my opinion a better option would have been to create another company “MicroHoo”. This company would be a merger of Yahoo and the Internet division of Microsoft including the recent acquisition of Aquantive. The Microsoft guys would run the administration/finance/sales/marketing/monetization and the Yahoo guys would be the creative side developing the content/sites. In this scenario, Microsoft doesn’t have to pay the 62% premium or dilute existing shareholders. It might put in additional cash into the merged company so that it has a controlling 51% stake.

As a Microsoft Shareholder I worry about the expected cost savings from synergies. I also worry if the approval and integration can be done in time to challenge Google.
I hope Microsoft thought about a merged company before they decided to just buyout Yahoo. Its possible that a merger was proposed but the idea was rejected by Yahoo. I guess Steve Ballmer sees a big opportunity and thinks that any futher delay in combining MSN and Yahoo would give Google an insurmountable lead. Only time if this buyout makes sense.
This article is just my opinion please do not base any investment decisions based on the article.

To read Microhoo - Round 2 the follow up to this article click here

Disclosure: I own shares of Microsoft.

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The video games industry is one of the fastest growing industries in the world. Its the creation of a new form of interactive entertainment. The industry is growing rapidly and will soon be bigger than the movie industry.

The “King of games”.
For years Nintendo was the king of video games, every competitor that challenged it was summarily demolished. The NES and SNES (Famicom in Japan) made Nintendo a synonym for video games. Their high quality in-house games and memorable characters like Mario, Zelda, StarFox, DonkeyKong started franchises that still sell games by the millions. Nintendo also introduced quality control of third party developers to made sure that customers had great games to play. As the video games industry took off competitors introduced competing consoles like Sega MegaDrive/Genesis, 3DO, Atari Jaguar, Sega Saturn, but they all failed because they didn’t have the games to back up the hardware.

The new kid on the block.
It was not until the PlayStation launch in 1994 by Sony that Nintendo faced its first true competition. The PlayStation was first to market. Sony introduced the CD format which had 10 times the capacity of a Nintendo cartridge which gave game developers creative freedom they never had on 32MB cartridges. The PlayStation was much easier to program than the N64 which helped Sony attract a lot of third party developers to PlayStation. When Nintendo released it Nintendo 64(N64), Sony already had a stranglehold on the market. What Sony saw was the creation of a new form of entertainment. The PSX has gone on to sell 100 Million units over 11 years and the PS2 surpassed that number in 7 years.

Two is company, three is a crowd.
Microsoft got its taste of the video game industry when it developed the operating system and development tools for the Sega Dreamcast. The growing video games market seemed to threaten the PC market which generated most of Microsoft’s revenue. The XBox was also a chance for for Microsoft to diversify it’s revenue stream, it joined the console wars in 2001.

What next?
The Next-gen Console wars are upon us. The competitors are Microsoft, Sony, Nintendo. The victor will receive control over a hundered million households.

Console Manufacturers
The money is made not in the hardware sales, usually consoles are sold at a loss. The profits flow in from licensing deals with software developers who want to publish games for the console. The more games that get developed and sold the higher the profit for the console manufacturer. The number of games developed and sold is directly proportional to the number of units sold.

Sony PS3 (SNE): The PS3 is a difficult release for Sony. Game developers like consoles to be positioned exclusively for gaming and not as media units. Selling a console as a media unit means game developers have no idea how many units were purchased for the purpose of gaming. Another risk factor for Sony is the price point, usually consoles sell for around $299-$399 at launch. At launch the PS3 will sell for $599-$699, agreed that it has a Blu-Ray player but the price is twice the XBox360. Sony lost the VHS v/s Betamax wars and is trying to win the HD-DVD v/s Blu-Ray wars. I’m afraid Sony may win the Hi-Def wars but lose the console wars.

Microsoft XBOX 360 (MSFT): First out of the block its projected to have 10 million units shipped before PS3 or Nintendo Wii make it to market. Improved production lines mean it will be able to cut prices when the new consoles launch, further improving unit sales.

Nintendo Wii (NTDOY): The new unique controller with motion detectors will provide a unique gaming experience. The Nintendo image of high quality kids friendly games will sell units to pre-teen audiences. Nintendo’s gaming franchises will also help sell a lot of consoles, especially in Japan. It wont win the console wars but it will be extremely profitable. Unlike Microsoft and Sony, Nintendo doesn’t depend on third party developers. It has the best game development unit in the world. The company can release a Mario, Zelda or Pokemon game and sell 5-7 million consoles.

Microsoft and Sony will sell more consoles but the video game revenues are a small part for both companies. As a pure play on video games Nintendo wins. Even without the console market Nintendo would do fine because its Game-Boy dominates the handheld market. The PSP isn’t even worth mentioning

Game Developers
As consoles improve independent game developers are closing down. Better hardware mean the customer expects better looking games. They want games that look as good as movies. The production costs of games are skyrocketing, with some games costing as much to develop as blockbuster movies. This has led to significant consolidation in the industry. The only companies that will survive are the big publishers.

Electronic Arts (ERTS): EA has excellent sports franchises which lets them publish sports games with minor tweaks every year that sell millions. It also controls franchises like The Sims, Battlefield, Medal of Honor etcetra that are million unit sellers. The best part about EA’s business is that it develops all games for all consoles, so it doesn’t matter which hardware manufacturer wins EA get its software sales.

Konami (KNM): The company that created the Dance Dance Revolution craze (I’m sure you’ve seen kids dancing on the floor-mats) has a lot of franchises like Metal Gear, Bomberman and Silent Hill, each of which will be made into multiple games for various consoles. The company posses a brand recognition in Japan that ensures its games will be blockbusters.

I like the consistency in earnings of Konami over EA. The majority of Konami’s revenue comes from console games but Konami also has some Arcade, Toy, Mobile and Casino gaming exposure that helps it weather the downturns in the industry at the end of each console generation.

Others: I do not like any of the other game manufacturers like Activision(ATVI), THQ(THQI), Atari (ATAR) and Taketwo(TTWO). They dont have the size, financial strength or game library/franchises that EA and Konami have. The one company i would love to own is Blizzard (Vivendi), too bad its not an individual company

Services
The only ones i know of are Shanda(SNDA), Netease(NTES) and The9 (NCTY). The companies provide services for On-line gaming and on-line communities. They’re just too risky.

Retail
Wal-mart and Best-Buy sell a lot of consoles and video games but there is only one company that is exclusively a video game retailer.

GameStop(GME): is the world’s largest video game retailer. The company operates 4,500+ retail stores throughout the United States, Austria, Australia, Canada, Denmark, Finland, Germany, Italy, Ireland, New Zealand, Norway, Puerto Rico, Spain, Sweden, Switzerland and the United Kingdom. To GameStop it doesn’t matter who wins the console wars and it doesn’t matter which game developer get the next blockbuster franchise. If the industry grows GameStop will mint money.

Best way to invest in video games : GameStop(GME)
Alternative : Nintendo (NTDOY)

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