Rating agency Fitch cited concerns on 15 June that this view reflected their “expectation for structurally higher leverage” in view of Microsoft’s intention to fund the LinkedIn acquisition mainly with new debt - and a significant amount of it.
Fitch’s analysts estimated that the Supplemental Adjusted Net Leverage, which offsets debt with a portion of Microsoft’s $106bn of offshore cash as of March 31 2016, would “approach 1.5x”, pro forma for the deal. They nevertheless affirmed Microsoft’s other ratings - the Short-Term IDR and Commercial paper - both at ‘F1+’.
Such issues aside, Microsoft was nevertheless able to subsequently issue $19.75bn of debt securities earlier this August across seven maturities to finance its LinkedIn takeover. Keenly snapped up yield-hungry investors seeking out income, the issuance represented the fifth biggest corporate bond sale on record from one of only two US corporate entities to hold a triple-A (‘AAA’) rating opinion from Standard & Poor’s.
But there are other questions too that can be raised over the deal in terms of valuing so-called ‘immaterial’ assets, which in basic terms are assets that in and of themselves do not actually generate money but are part and parcel of the overall offering.
While LinkedIn’s primary sources of revenue - namely aiding corporate recruiters and advertising - are well-documented, business-oriented social networking services provide a host of other intangible value-adds. And, while it is one thing saying these assets may have some value, quantifying matters can prove a harder exercise.
Quantifying Benefits
From the online presence of industry thought leaders who author ‘influencer’ articles, to ‘sync-up’ potential with users’
This is a view according to Peter Wollmeringer, Managing Director in Huron Consulting’s Business Advisory practice in New York, who has two decades of industry experience. Huron, which is largely a domestic management consulting firm which was formed back in 2002 that specializes in sectors including healthcare, financial services and higher education, provides business advisory services spanning bankruptcy, litigation, M&A, restructurings and valuations.
Wollmeringer, originally from Massachusetts and based now for the past 14 years in New York and who works in the firm’s commercial business valuation practice, says: “The Microsoft acquisition of LinkedIn is something that has interested me because I use LinkedIn all the time and find it to be a valuable tool for connecting with people.”
With over two decades of experience in advising clients on the strategic valuation of assets, financial reporting, restructuring and M&A activity, Wollmeringer is perhaps well versed in discussing the somewhat nebulous topic of valuing immaterial assets. It might also serve as something of a primer on the topic. For others it may appear like something akin to a minority sport.
By way of background in the valuation space, Wollmeringer helped co-author a recent document that was recently published by the Appraisal Foundation, a Washington, DC-headquartered body that is regarded as the foremost authority in the US on the valuation profession that sets Congressionally authorized standards and qualifications for real estate appraisers. Additionally they provide voluntary guidance on recognized valuation methods and techniques for all valuation professionals.
‘Immaterial’ Assets
So what we do mean by immaterial assets then and how can their worth be pinned down and quantified exactly?
“It doesn’t have an absolute definition as such and I’m not sure that it is scientific," says Wollmeringer, a graduate from the University of Massachusetts Amherst. “This is because we (e.g. valuation professionals) rely on the companies themselves to help us in how we construct a valuation of the acquired assets and provide information on why they think these immaterial assets have value.”
He adds: “However, in a case like this there really are not that many social media companies that are on the receiving end of being acquired. And, certainly not one as big as this [LinkedIn].”
He goes on to say that if one looks at what they [LinkedIn] have, some of the business lines make some money. “It is largely a recruiting business that generates nearly all the revenue…little else has a material revenue stream associated with it (free subscribers, paying subscribers and advertising).”
All the other LinkedIn activities that attract people and users (e.g. where you can find people, discover lots of great things and information, and SlideShare), simply do not appear to directly generate any money. This in essence is the “key thing” in Wollmeringer’s view and equates to a group of immaterial assets as on the surface that do not make money.
LinkedIn does not report such service offerings as cited above as generating money. However, as Wollmeringer posits, all these things together “draw people in" and that is where he believes the engine is. "Presumably there would not be a successful recruiting business if the massive amount of people/data did not exist on the LinkedIn platform,” he suggests.
The Candle Drawing Users In
Using an analogy he remarks: “It is sort of like the flame that everybody gets drawn in by. People see things they like and at some future point in time they perhaps start paying money for other things.”
But he adds: “That is not something that it looks like most LinkedIn subscribers are doing though. Recruiting and the talent services seem to be the dominant element of the business.”
Quantifying Benefits - Challenging
As it regards quantifying benefits and in relation to LinkedIn’s Freemium service that offers a wealth of benefits, Wollmeringer says: “I think it would be challenging to be quantified. The company is going to have to do acquisition accounting for this deal. And, a large part of the price will likely be goodwill and then there will be the valuation of assets related to the recruiting side of the business.”
That, he adds: “Will be the biggest intangible asset - customer relationships with the recruiters. While the free subscribers contribute the value of the recruiting customer value, their value will be challenging to quantify.”
There is also the trade name to consider and the unique technologies that enable the services. Some of the other services that do not appear to generate an income stream include LinkedIn SlideShare, a Web 2.0-based slide hosting service that has around 38m registered users and whose website has generated an estimated 70m unique visitors per month. And, here there appears to be only a small number of paying subscribers.
Meanwhile Lynda.com, a leading online learning platform that helps anyone learn business, software, technology and creative skills, is a pay service that was acquired by LinkedIn in April 2015.
Valuations
Usually in valuations, Wollmeringer says, one looks at what asset(s) is/are driving the business. “Here [with LinkedIn] we see that more than $3bn of revenue is within talent services, which will be where the main focus of the valuation will be.”
This can be broken down by: (1) Cash flow associated with fees that the company is getting paid by recruiting firms and other companies across the world; (2) Paying subscribers; (3) Advertising; and (4) Others. “These four aspects could probably be looked at independently or separately,” he contends.
Valuing LinkedIn’s Users
Research firm Trefis recently produced a note in which they examined how Microsoft’s LinkedIn’s bid price valued each LinkedIn user and how LinkedIn stacked up with the other social media players - Facebook and Twitter.
Providing a useful table and comparison, Trefis stated: “It is evident from the following calculation that with a $26.2bn valuation, LinkedIn’s monthly active users are valued at $248, which is 23% more than Facebook’s users, and over 7.5x of Twitter’s active users.” In explaining the differences it added
Furthermore, LinkedIn was ahead of the other two companies in generating revenue per user, which Trefis cited at being $28.30 per year and equated to c.3x that of Facebook and around 4x for Twitter. In terms of the major factors driving the difference in valuation between LinkedIn and Twitter was LinkedIn's "relatively faster user growth" according to Trefis and significantly higher free cash flow generated compared to Twitter.
Methodology For Valuing Immaterial Assets
In respect of the methodology for valuing immaterial assets, Wollmeringer says: “It is hard to say exactly for something like this and will depend on how the valuation analysis is weaved together. They will start with the material assets first. And, I suspect that the recruiting customer asset will be valued based on the cash flows it generates - often called an excess earnings method.”
This method measures the cash flows associated with the asset, and then deducts charges for the use of other assets that contribute to the cash flows like the LinkedIn trade name.
Technology & Trade Name
The trade name and underlying technologies might be valued assuming they could be licensed. In other words, what hypothetical royalties would Microsoft be avoiding by owning these assets.
These may be unique assets and finding good market data is challenging, nonetheless, the approach to valuing these types of assets is fairly common in the technology space. That said, Wollmeringer contends: “They could have a reasonably sizeable value.”
Huge Collection of 'Other' Stuff
Subsequent to this there is a “huge collection of other things” according to Wollmeringer that make up the immaterial assets featured on LinkedIn’s platform, which do not appear to generate any income directly.
For instance, the core Freemium service of connecting to people and institutions (i.e. companies and universities), email, influencers, sharing information, and SlideShare. For all such activities or features, LinkedIn could “find a way to spread income/revenue in some logical way,” he points out.
One might also look at parts of the technology and infrastructure to the business (e.g. SlideShare) in terms of how much it originally cost to build over what it would cost to implement a replacement today.
“It is typically not a great method,” acknowledges Wollmeringer. “But it is a possibility for things that do not generate income.” However, it is also possible that some form of replacement cost or market price of data would be used, rather than splitting revenue into many buckets.
“If these assets are valued separately from goodwill, they would represent economic rents associated with the recruiting customer asset,” the Huron Consulting executive argues.
At the end of day valuing immaterial assets is not a stroll in the park - be it related to social media assets or in other sectors. It is a challenging valuation exercise with these types of assets. And, as Wollmeringer says “very likely most of them will be subsumed into goodwill”. This is because there is not going to be either a reasonable or strong economic model to measure the worth of these assets.
