When Acquisitions Attack!

Microsoft will live to code another day but limps away wounded.

Evan Niu
Evan Niu, CFA
Jul 3, 2012 at 12:00AM

So there you are, one of the mightiest tech companies in the world, strolling along during a peaceful sunny day, minding your own business. All of a sudden, out of nowhere, an old acquisition from the past leaps out from the shrubbery and attacks! It latches on to one of your appendages and you try your darndest to shake it off. You're able to fend it off and escape mostly intact, but alas, it takes a sizable chunk of your vitals with it.

That's how Microsoft (Nasdaq: MSFT) feels right now. The acquisition in question is none other than the $6.3 billion acquisition of aQuantive way back in 2007, and the appendage that was injured was the software giant's online services division, or OSD. It would seem that the 85% premium that Mr. Softy paid may have been a tad too premium in hindsight.

aQuantive would go on to become part of Microsoft's advertising business, while its Bing search engine would be launched two years later in June 2009, hoping to take on Google's (Nasdaq: GOOG) hegemony. Three years later, Apple (Nasdaq: AAPL) would also make an advertising-related acquisition with Quattro Wireless in 2010, which would become its iAd mobile advertising platform.

How much are we talking about?
Microsoft is writing down $6.2 billion of the goodwill within its OSD. It's worth noting that at the time of the acquisition, the company recorded $5.3 billion of goodwill assigned to the OSD, bringing its total carrying balance up to $5.9 billion in September of that year. The goodwill in the OSD had climbed up to $6.4 billion by March of this year, so this accounting charge is wiping out the vast majority of that figure.

The company said that aQuantive provided tools to bolster its ad business, but the deal didn't "accelerate growth to the degree anticipated," leading it to eat a massive chunk of that premium it paid back in 2007. It's also a definitive admission that the acquisitions it's made for the sake of growing Bing and the OSD have not worked out, while aQuantive has been the largest contributing factor.

The OSD segment continues to generate operating losses, although they narrowed to $479 million in red ink last quarter, an improvement compared with the $776 million in blood a year prior.

Here's how Microsoft's total goodwill was broken down as of the end of March.


Goodwill Balance as of March 31, 2012

Windows and Windows Live division $89 million
Server and Tools $1.1 billion
Online services division $6.4 billion
Microsoft business division $7 billion
Entertainment and devices division $5.1 billion
Total $19.7 billion

Source: 10-Q filing dated April 19, 2012. Note that figures may not add up exactly because of rounding. 

Looking at Microsoft's overall consolidated goodwill, it was carrying $19.7 billion before this announcement, so the charge eliminates nearly a third of that carrying balance. This is before you include the $2.8 billion in net intangibles that the software giant is also sitting on.

Who's next?
One can't help turning focus to another recent and questionably large acquisition from Microsoft: Skype. After eBay (Nasdaq: EBAY) famously overpaid for the online video-calling service, Microsoft decided it was its turn to pay even more for it last year at $8.5 billion. Since we've been discussing goodwill at length, it's worth mentioning that Microsoft allocated $7.1 billion to goodwill related to Skype.

Of that total, the vast majority was primarily split between $4.2 billion to the entertainment and devices division, which includes other products like the Xbox and Windows Phone that are natural fits with video calling, with $2.8 billion going to its business division, home of many of its enterprise software offerings like Office and SharePoint, among others.

If Skype doesn't work out as well as hoped, much like aQuantive, there's plenty of goodwill related to that deal to eat in case aQuantive didn't satiate Mr. Softy's hunger for misplaced acquisitive spending.

Walk it off
This is the dark side of acquisitions. If they don't pan out as hoped, indigestion can be quite painful. Just ask Hewlett-Packard (NYSE: HPQ) about its Palm acquisition, after it got hit with $3.3 billion in after-tax costs and charges related to the botched deal. That's well more than twice the $1.2 billion that it paid in the first place!

Of course, Microsoft is so enormous that this non-cash charge won't affect its ongoing business or financial performance, but that's still a lot of shareholder money down the drain.

Instead of advertising, maybe Microsoft should have focused on its own Big Data offerings, since that's an area ripe with growth that this company is tapping into. Microsoft is definitely a player in the hot sector, but a pure-play might be more profitable for investors.