Earlier today, Microsoft and LinkedIn announced a deal whereby Microsoft were planning to buy LinkedIn for a little north of $26 billion. Microsoft are one of the world's largest software companies, famous for their flagship Windows operating system and Office products. LinkedIn occupies a strange place in the world of social networks. It's a social network designed for business and networking, structured in a broadly similar way to other platforms, such as Facebook. Both LinkedIn and Microsoft have been through an interesting couple of years: Microsoft has finally stopped trying to push its mobile operating system platform onto customers, Windows Phone, and has even released an upgrade to its popular Windows operating system free of charge for many customers. Instead, Microsoft is reinventing itself as a software and cloud computing company. Its flagship Office product is moving to a cloud based experience and the company has worked on releasing software for its products onto many different platforms.
LinkedIn as a business generates revenue from a number of different sources, such as its premium or subscription model, advertising revenue and its recruitment business. The advertising revenue side of the business has been underperforming. Advertising accounts for around one fifth of the business revenue, but the revenue generated from this part of the company had been growing considerably slower than market expectations. In February 2016, LinkedIn reported on the Q4 2015 and its figures showed that advertising revenue had grown by only 20%. For some companies, an increase in advertising revenue of 20% would be seen as cause for celebration but for LinkedIn, where for Q4 2014 the growth in advertising revenue was 56%, this was bad news. eMarketer, a research firm, predicted that LinkedIn's US digital advertising revenue growth would fall from 56% in all of 2015 to under 10% in 2016. The company lowered 2016 forecasts in February and the share price took a tumble, devaluing the company. Shortly after the Q4 2015 data was released, we understand that the LinkedIn started discussions with Microsoft.
As a publicly traded business, LinkedIn also has stockholders to keep happy. Unfortunately, LinkedIn's stock price had been falling, having almost halved from the early 2015 point of $270 a share. Stock prices reflect how a business may grow profits looking forwards and a decline in stock price points towards a business with deteriorating growth prospects. Traditionally, stock prices reflected the likely dividends that would be paid by the company as a share of the profits made by that business, although in the last two decades this traditional way of rewarding investors has changed somewhat.
Why did LinkedIn agree to the Microsoft deal? There is likely a simple answer to this question: the economies of scale. LinkedIn has struggled to sell digital advertising so could tap into Microsoft's expertise in this area. Microsoft's considerable user base should also help LinkedIn user numbers; LinkedIn is a neat fit into Microsoft's portfolio of business services such as Office 365, OneDrive and Skype. What did Microsoft gain for their $26 billion? In addition to LinkedIn being a good fit into its business, the company has many characteristics of a well managed business. Providing LinkedIn with more customers could dramatically increase the profits, which in turn should provide Microsoft with a healthy return on its investment. It is also possible that Microsoft value the LinkedIn Chief Executive Officer, Jeff Weiner.
The ink on the deal has not yet dried. Microsoft and LinkedIn are yet to receive regulatory approval. The acquisition brings about it many questions and relatively few answers: Microsoft bought LinkedIn at a price of $196, a 50% premium to Friday's close but some way lower than it was in early 2015 at around $270. However, if Microsoft can turn around the advertising business and increase the number of customers, LinkedIn could be reinvigorated. It will be interesting to see how well the businesses adapt to fit around one another.