Tech Empires Aren't Good For Shareholders

By Yale Bock - September 18, 2012 | Tickers: DELL, EXPE, GOOG, IACI, MSFT, SNE | 0 Comments

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The corporate titans of today’s tech world would be better off in parts rather than as wholes. The job of management is to generate shareholder value, not to build massive integrated empires with cash that yields one and a half or two percent. Rather than acquiring more divisions, these massive companies should spin divisions off into leaner, more agile companies.

Microsoft (NASDAQ: MSFT) is one company that has done quite a bit of mergers that stray from its core business. Some have fared better than others, certainly. But as many studies have shown, a lot of this merger activity actually destroys value. Microsoft today has just three divisions that make money while the rest of them just drag them down. My experience is corporate restructurings, spinoffs, or divestitures are usually value creation vehicles, especially if the leaders of the companies have clear reasons for undertaking a break up of a larger enterprise. There are plenty of consultancies out there whose job it is to identify underperforming divisions of companies and recommend getting rid of them.

Here is why spinning off divisions can help each division create shareholder value and compete in the marketplace.

First of all, Microsoft is, quite obviously, big. The company made a profit of $21.763 billion on $73.723 billion in revenue in its fiscal year 2012. For a company like that to grow 10%, it has to generate another $7.3 billion in sales. Of course, this is not easy. It’s especially difficult to pull that off when the company is supporting a zombie Online Services Division that lost over $8 billion over the course of that year.

Let’s say for example, they spin off just the Server and Tools division. On its own, this service books nearly $20 billion in sales. It’s much more likely that this spun-off division will find another $2 billion in revenue next year than Microsoft as we know it making another $7 billion. Also, as its own company, Server and Tools would be unencumbered by the lagging segments. It can hire its own management and it would also have a currency (their own stock) to make acquisitions. They might even be able to rid themselves of the disastrous “stack ranking” management system that ex-employees so often say stifles innovation at Microsoft.

Some might point out that there are advantages to scale. Bigger tech companies have to be able to fight lawsuits, lobby the government, and provide for losses and write downs when things aren’t going very well. They also have to be able to do technical research to stay ahead of the curve. But even if Microsoft’s Windows's, Servers, Business, and Entertainment were all separate companies, they would each be rather large-scale businesses able to support all of these things.

IAC/Interactivecorp (NASDAQ: IACI) under Barry Diller is practically a case study in spinning off even very profitable units to create shareholder value. Originally, IAC owned Expedia, Trip Advisor, LendingTree, Ticket Master, the Home Shopping Network and Integral Leisure Group.

At the time that they were spun off from IAC, those units accounted for the lion’s share of the parent company’s revenue. Working independently, however, these units have grown more profitable and brought sizable returns to shareholders after the general market improved. Expedia (NASDAQ: EXPE), for example was spun off from IAC in the summer of 2005. Since then, the company’s share price has gone from $46.74 to $55.07, but with a 1:2 split. Expedia even started giving dividends to shareholders in 2010.      

IAC itself was able to focus more on its core business of Internet content and its share price has gone up nearly 200% since its own stock split in August, 2008. Contrast this with the middling returns that Microsoft delivered while it chased all sorts of new businesses like Bing.

Also, size alone doesn’t necessarily result in returns for shareholders. Take for instance Sony (NYSE: SNE). Without a doubt, it’s big and has it has presence in tons of markets, but that hasn’t protected it from falling behind rivals and performing badly in the market.

As for Microsoft, there is no real sign that the company is considering spinning off or downplaying its money-bleeding Online Services Division. In its latest quarter, it did give in and wrote down $6.19 billion in goodwill for aQuantive, an online advertising platform that it acquired in 2007 to compete with Google.  Microsoft’s partnership with Nokia and integration of acquired technologies such as Skype and Yammer into its portfolio of products gives it a toehold in growth businesses outside of the stagnant PC market, but again, it isn’t creating shareholder value.

The caveat for investors is trying to find situations where management actually considers a break up, versus just building a larger empire. The large technology companies have yet to actually break themselves up, yet if they ever decided to go that route, it would prove strategically very wise. Stay on the lookout for these kinds of potential situations, both announced and unannounced.

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