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Prices paid in tech deals about more than just the value of the target business, says expert

Out-Law News | 27 Feb 2014 | 1:50 pm | 3 min. read

The chance to acquire a talented pool of innovators is one reason why technology companies may appear to overpay when buying smaller tech businesses, an expert has said.

Corporate law expert Andrew Hornigold, a specialist in technology mergers and acquisition deals, said that there are several reasons technology companies may pay more than a target business appears on the face of it to be worth to acquire those companies. He said 'acqui-hiring' is a growing trend as technology companies seek to grow their business and develop the next big product or service.

Facebook recently reported that it has agreed to buy messaging service WhatsApp for $19 billion. WhatsApp charges users a nominal $1 annual fee to use its service after providing an initial year free and has reported annual revenues of $20 million.

Hornigold said that the value of the takeover deal "didn’t appear to be based on normal market metrics" but said that, as well as acqui-hiring, technology companies have other reasons why they may overpay when buying a business.

"'Acqui-hiring' is the practice of buying companies with the purpose, at least in part, of bringing genuine innovators within the umbrella of your own organisation," Hornigold said.

"You effectively pay for expertise and talent on the basis that there are very few people who are able to replicate what they have achieved – delivering ground-breaking technology products, genuine innovative research and new disruptive services to the market and making it a commercial success. In acquiring their business, you are buying into the belief that the people behind those companies are going to deliver new products or services in the future within your own company as much as believing in and enhancing what they have already delivered. It is a long-term investment," he said.

He said businesses may want to kill off threats to their own companies by buying companies that pose an existing or future threat to their business models. Businesses may also be motivated to buy companies to prevent rivals doing so and strengthening their own service offering. Organisations may also pay in excess of what an individual business is worth to gain easier access to new markets, Hornigold added.

"WhatsApp has announced that it will offer free voice call services to its customers," Hornigold said. "From Facebook's perspective, acquiring WhatsApp signals its intention to expand its own messaging services and use the WhatsApp brand and existing strong customer base to gain a foothold in the voice market."

Telecoms law expert Jon Fell of Pinsent Masons echoed Hornigold's view that the acquisition could be viewed as a "defensive acquisition" designed to prevent WhatsApp growing its business at the expense of its own.

Fell said that traditional telecoms companies were already being forced to take account of 'over-the-top' applications such as WhatsApp. He said that the existing presence of Microsoft-owned Skype in the market for voice calls meant that WhatsApp's move into the voice market would not present a "new challenge" to telecoms companies' business models, since those companies were already used to such "disruptors" entering the market. However, he said it would certainly add considerably to the challenges facing those telcos.

"It is interesting to try to work out how Facebook will reconcile its own business model, which is built on selling advertising, to the low-cost, initially free, service offered by WhatsApp entirely without advertising," Fell said. "The next big question will be whether consumers will continue to trust an increasingly small, exclusive club of giant internet companies having total access and control over their data."

"Consumers have shown themselves to be happy to give up an element of privacy to gain access to services they see as serving them primarily. However, their attitudes may change where they see services as glorified corporate advertising vehicles. Where services start to become a 'turn off' for the consumer, there is the potential for newcomers to emerge in a market, perhaps with a slightly different business model, and prise consumers, and revenue, away from the biggest companies," he said.

Fell said that technology companies may never see a return on their investment from the huge prices they are paying to buy up smaller tech businesses and warned of a return to the "dot com era bubble".

"Recent deals are perhaps reminiscent of what happened in the late 1990s' where there was a trend in buying internet companies," Fell said. "Back then the value of an internet company was generally calculated on the number of users those businesses had. However, it soon became obvious that there was no direct correlation to be made between the number of users and the cash that could be generated from this number so many deals failed. There is a similar question mark hanging over the sustainability of contemporary tech deals where inflated prices are being paid."