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Market Rebound: Merger mania is back

Posted February 1, 2008

"If you understand how companies grow and evolve, you can predict when they will falter and die. Microsoft achieved its maximum efficient size over a decade ago. " – Andrew Snyder 

By Andrew Snyder

Baltimore (TFN): A Wall Street titan is dead.  It grew so large and its weight got so cumbersome its knees buckled.  As I write, the all-American giant is crumbling to the ground with cash spewing out of every orifice. 

In case you missed the news this morning, Microsoft (MSFT:NASDAQ) just made a historic move.  It announced it is willing to purchase Yahoo! at a the jaw-droppingly high price of $31 per share.  History books will show paying the 62% premium will go down as one of Bill Gates' greatest blunders.

I have spent a good part of my career studying business life cycles.  If you understand how companies grow and evolve, you can predict when they will falter and die.  Microsoft achieved its maximum efficient size over a decade ago.  Since then, every growth spurt has led to less efficiency, slower product growth, and declining equity valuations. 

Today's news that Gates will buy Yahoo! at nearly any price is all the evidence the coroner needs to zip up the body bag and declare Microsoft legally dead.  When the only way a company can find growth is to pay an extreme premium for it, there are major flaws in its strategic plan.  Instead of buying Yahoo!, Microsoft needs to be selling its less-critical business segments to the floundering search engine.

Ego Spending

But when your CEO is the world's richest man, what is a few billion dollars in lost shareholder equity?  It is apparent this move is not about profitability.  It's all about ego.

One person that loves the possibility of a Microsoft/Yahoo! merger is Eric Schmidt, the chief executive of Google (GOOG:NASDAQ). His ego is soaring this morning.

For the last five years, Google has outsmarted, outpaced, and outsold Yahoo! and its meek search engine presence.  Just because Microsoft may be getting involved, does not mean Yahoo! is suddenly going to surge in popularity or profitability.  For Google, it is simply one more competitor out of its way. 

For investors, this is a great time to take a close and hard look at Microsoft and its investment value.  If you are holding the position long and you were not lucky enough to sell out before all of this news, you are going to have to keep holding for quite a while longer before share price appreciates back to yesterday's valuations.  Share price is already dropping because of the news.

They lose, you win

If you are looking to make money off this deal, you have two options.  The simplest is to wait a few days and buy shares of Google.  Its share price took a sizeable dip on the news.  Believe me, it will be back up in no time as Wall Street works its magic.

Your second option, and the one with the most profit potential, is to short Microsoft using put options.  The April 08 puts are going to experience huge amounts of volatility over the next three months.  Buy something with a strike price close to yesterday's closing price of $32.60 and you could rack in some hefty gains.

Do not ever forget that Wall Street represents living, breathing corporations.  Just like everything else on this earth, those companies mature and grow.  But the process can only last so long.  After a period, every company hits a growth ceiling and all it can do is spread out, reducing profitability. 

Today's merger talk is proof that Microsoft has reached its peak.  Now, the only way it will find more profits is if it spends a premium for them. It won't be a pretty death.


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Posted by Andrew Snyder · Filed Under US Stocks and Markets 

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