Courtesy of David Gelles. 17 August 2014.
MOUNTAIN VIEW, Calif. — When deciding whether Google should spend millions or even billions of dollars in acquiring a new company, its chief executive, Larry Page, asked whether the acquisition passes the toothbrush test: Is it something you will use once or twice a day? Does it make your life better?
The esoteric criterion shuns traditional measures of valuing a company. After all, earnings, discounted cash flow or even sales are typically deemed the top priority. Instead, Mr. Page is looking above profitability and toward long-term potential for financial gain.
Relying on Internal Teams
Google’s toothbrush test highlights the increasing autonomy of Silicon Valley’s biggest corporate acquirers — and the marginalized role that investment banks are playing in the latest boom in technology deals.
Many of the biggest technology companies are now going alone when striking large mergers and acquisitions. Companies like Google, Facebook and Cisco Systems are leaning on their internal corporate development teams to identify targets, conduct due diligence and negotiate terms instead of relying on Wall Street bankers.
“Larry will look at potential deals at a very early stage,” said Donald Harrison, Google’s vice president of corporate development. “Bankers can be helpful, but they do not necessarily core to the discussions.”
Deals with unadvised buyers are increasing rapidly. The acquiring company did not use an investment bank in 69 percent of American technology acquisitions worth more than $100 million this year, according to Dealogic. That number was 27 percent 10 years ago.
Striking Deals without Bankers
When Apple bought Beats Electronics for $3 billion this year, it eschewed the help of professional deal advisers. When Facebook spent $2.3 billion for the virtual reality company Oculus VR in March, it did it without bankers. And when Google acquired the mapping company Waze for $1 billion last year, no bank got a cut of the fees.
In June, one of the largest-ever deals with an unadvised buyer was announced when Oracle, known for its refusal to use investment bankers, acquired Micros Systems for about $5 billion. The biggest such deal came in 2011, when Microsoft, acting alone, bought Skype from Silver Lake Partners for $8.5 billion.
The diminished reliance on investment banks comes as technology deal-making is booming. More than $100 billion in such deals have been announced in the United States this year, the most since 2000, according to Dealogic.
The Problem with Bankers
At the heart of the disconnect between technology companies and banks is the belief among many tech executives that some advisers simply do not know what companies like Google and Facebook are looking for.
“Bankers do two things well: financial evaluation and negotiation,” said Richard E. Climan, a partner at the law firm Weil, Gotshal & Manges who often works with companies to complete deals where no banks are involved. “But there’s a feeling that investment bankers might not be so important on the evaluation of early-stage tech companies.”
Amin Zoufonoun, Facebook’s vice president for corporate development, said some bankers would come in and pitch acquisition candidates like the user reviews site Yelp or the payment network PayPal. But instead of trying to swallow already established Internet brands, Facebook uses acquisitions to make big bets on the future and plug technical holes. And in Silicon Valley’s relatively small circle of elite entrepreneurs, executives and venture capitalists, connections are easy and ample.
“It’s more art than science at times.”
Facebook’s most recent big deal, the acquisition of Oculus VR, came as a surprise to even seasoned technology watchers. But Marc Andreessen, a Facebook board member, was also on the board of Oculus VR, paving the way for the deal. The move had nothing to do with improving the social network’s main site or increasing sales. Instead, it was a bet that virtual reality would emerge as a new operating system of sorts.
While other companies focus on deals that will bolster their earnings per share, “we haven’t done a single deal like that, where we are looking at a target with that being a rationale,” Mr. Zoufonoun said.
The same dynamic was true when Google acquired Nest, the home monitoring company, for $3.2 billion this year. Nest’s current sales are a drop in Google’s ocean of profit, but the deal gave Google an entry to a potentially huge new market.
Big tech companies sometimes struggle to explain such unconventional deals to investors. When Facebook spent $19 billion to acquire WhatsApp, assisted only by the boutique bank Allen & Company, shareholders tried to square the enormous price with WhatsApp’s small team of engineers and minuscule revenue.
“It’s more art than science at times,” said Sanjay Kacholiya, head of corporate development at Eventbrite, a ticketing start-up. “That can make it difficult for an investment banker who’s familiar with earnings per share and discounted cash flow.”
The Downfalls of Unadvised Deals
Unfortunately, not all unadvised deals go well. Google spent $228 million on the social games company Slide without the help of a bank, then unceremoniously shut it down. Cisco didn’t work with a bank when it paid $590 million for the maker of Flip video cameras, and it wound up shuttering the unit quickly. But thanks to tech companies’ enormous war chests, such mistakes rarely have long-term consequences.
While traditional investment banks might not be comfortable suggesting that clients pay such startling prices for relative unknowns, many big tech companies have built up robust corporate development departments designed to do just that. The teams are largely staffed by former bankers who have abandoned pinstripes and wingtips for T-shirts and sneakers.
Hiring Full-time Bankers
Cisco, which owns over 170 companies, finds that it is more efficient and economical to hire its own full-time bankers. In turn, Cisco saves a lot of money. Otherwise, they’d be paying millions of dollars in fees each time it struck a deal.
“Our heritage has been embracing M.&A. as a way to enter new markets,” said Hilton Romanski, Cisco’s head of corporate development, who started his career as a JPMorgan banker. “It makes sense to build a relatively scaled effort around M.&A. with teams and talent that understand the market.”
Facebook has hired bankers away from Credit Suisse and Jefferies, among other companies, and gives them more responsibility than they would have at a bank. “They can run a deal from beginning to end,” Mr. Zoufonoun said. “As an analyst, they were doing one part of a pitch deck.”
The Trick: Maintaining Good Relationships
At Google, Mr. Harrison has an employee looking after the deal needs of each of the company’s 12 product areas. These product areas include ads, YouTube, and search. That person goes to all meetings held by the senior members of that group, staying attuned to possible acquisition needs.
But the hours are not necessarily any better than on Wall Street, said Mr. Zoufonoun, who kept awake several nights in a row working to close the WhatsApp deal, falling asleep at the office the day the deal closure was a success.
Once a target is identified, and it is time for an approach and negotiations, corporate acquirers working on their own often diverge from the standard advice given out by bankers.
Mr. Zuckerberg developed friendships with the chief executives of Instagram and WhatsApp before Facebook went on to buy them. Only after the men knew one another well and began discussing integrating the products did discussions about actual transactions begin. Even then, much of the focus was on how autonomously the target company would operate once acquired.
“It’s very easy to treat M.&A. transactionally, to not put the target company first. Are we aligned? Do we want the same thing post-acquisition?” Mr. Zoufonoun said. “I always use the marriage example. You should spend a lot of time dating first. It takes two to dance.”
The real work of merging corporate cultures begins after a deal. “The success or failure of deals is really determined by the success or failure of the integration,” Mr. Harrison said, adding that Google closely monitored new acquisitions for two years.
The trick is to strike the right balance of blending teams while also allowing for a measure of autonomy.
“The last thing you want to do as an acquirer is going in there and start changing things around,” Mr. Zoufonoun said.
Tech companies maintain good relationships with banks and use them on big deals when financing or fairness opinions are necessary. When Google acquired Nest, for example, Lazard provided a fairness opinion to Google’s board.
Often, when big tech companies are looking to grow, it is the culture and vision, not earnings and revenue, that are paramount. And for the likes of Facebook and Google — shareholder darlings that are flush with cash and run by well-connected entrepreneurs — it is easier than ever to get by without bankers.
“The most important thing is that soft stuff,” Mr. Zoufonoun said. “And that soft stuff is more challenging for a bank or an adviser to tap into.”