I read a fascinating article on Minyanville. The author, Andre Mouton, believes that investing into web properties could be a fool’s game. It is a great article; I definitely recommend all of you to read it.
Andre Mouton believes that Yahoo! Inc. (NASDAQ:YHOO) could have run itself into a ditch with its recent acquisition:
One of Yahoo! Inc. (NASDAQ:YHOO)’s biggest difficulty has been in investing into web properties at a profit. In certain cases, it lands a home-run (Alibaba), but sometimes the company falls short by buying into web properties like Flickr.
Web properties are known to move through the life cycle curve at a very rapid pace. Rapid growth, maturity, and decline could happen all within a single decade. Sometimes, product demand declines due to perfectly natural causes like changes in the technology landscape, or better alternatives. In the end, the market constantly changes. It ebbs and flows in an unpredictable and never ending manner.
What sounds like a practical investment opportunity sounds ridiculous weeks, if not months later. The decline of social networks and the rise of new ones are something that makes it difficult for fully matured technology companies to invest into. Infant web properties like Flickr, MySpace, Deli.co.us, are all examples of what was once hot, now is not.
Silicon Valley executives have done their best to understand the constantly changing business environment. By understanding the environment, they have come up with a workable way to generate returns like clockwork.
How fully matured technology companies sustain growth
Yahoo! Inc. (NASDAQ:YHOO) has cut sales, general, and administrative costs by 27.6% over the past five years, the company also cut research and development expenses by 27.5% over the past five years. The spending cuts allowed the company to grow net income by 841% over the five-year period. The cash that was used on R&D and sales expenses was re-directed to M&As.
Yahoo! Inc. (NASDAQ:YHOO) isn’t hoping for every M&A to turn into a smash-hit success. What Yahoo! Inc. (NASDAQ:YHOO) is hoping to accomplish with an acquisition strategy is to increases its odds of buying into a successful web-property prior to hitting the rapid growth phase. Just one successful attempt at this can lead to solid returns on investment. A good example of this is Yahoo!’s successful purchase of Alibaba for $500 million which it sold for $7.1 billion. This proved that Yahoo! can successfully identify phenomenal investment opportunities. Yahoo! operates a business that is sort of similar to modern day private equity.
Private equity companies are armed with some of the world’s smartest people from business schools. Many private equity managers will acknowledge that most web-based companies will lose money and will be non-existent in the next five years. The companies that go onto become successful (1 in 10) will make up for the other nine that are losers. Yahoo! Inc. (NASDAQ:YHOO) is just like any other private equity firm. As long as one in ten of its acquisitions succeed and the other nine lose, Yahoo! will be able to make up for it by turning in great returns on investment as it did with Alibaba.
Yahoo! isn’t the only one
Google Inc (NASDAQ:GOOG), similar to Yahoo!, would probably go on acquiring companies in order to sustain growth. In certain instances, the company is focused on strategic acquisitions. Sometimes, Google Inc (NASDAQ:GOOG) goes out and buys small web properties.
The company is focused on generating yields from its investments. More importantly, Google Inc (NASDAQ:GOOG) is trying its best to deplete the cash balance on its balance sheet. The company currently has $48 billion in cash and short-term investments (short-term investments are highly liquid investments that can be sold immediately). The company has brought in $16 billion in cash from its business operations in the last year alone. Google cannot afford to keep money lying around.