As you may have heard, Microsoft is offering to buy LinkedIn for $26.2 billion. This deal has so many different implications, not just for Microsoft specifically, but also for tech company balance sheets and valuations.
Microsoft has over $100 billion in cash, mostly held overseas, but the firm has decided to finance this acquisition with debt. With interest rates near zero, they can borrow to buy LinkedIn, and in the meantime use their cash hoard for other uses that may provide higher returns than the interest paid on the debt. Apple has been doing this for a while now. They frequently borrow at these low rates and use the funds for share buybacks and dividends.
This type of behavior concerns me. Not for the individual companies that take advantage of it (it makes complete financial sense), but for the economy as a whole. Central banks around the world have lowered interest rates to near-zero, and in some cases, below zero, for quite some time now. The thinking behind lowering rates is that corporations will be more likely to borrow, and then they will use the cheap money to make investments, thus increasing GDP and benefiting the economy.
This environment caused 2015 to be the biggest M&A year in history. Instead of using the low-interest debt to make investments in new buildings, projects, or people, corporations have instead decided to use the debt to make acquisitions. This isnt necessarily a bad thing if the M&A deals can produce large increases in productivity for the corporations, but I highly doubt this is the case. In fact, throughout history, many research studies show that on average firms overpay for their acquisitions. There are many reasons why companies still partake in M&A activities even though they know of this history of over-payment. Some reasons include management ego, investment banking persuasion, and many others, however, this is a subject for another time.
On Microsofts balance sheet, they will show a book value for LinkedIn, and the remaining value over book value will be entered into Goodwill. Goodwill is essentially the value of any expected synergies or benefits that Microsoft expects the acquisition to generate over time. If the synergies or benefits never materialize, then an Impairment to Goodwill charge will occur, thus lowering the value on the balance sheet. Given that 2015 was the biggest M&A year ever, Goodwill on company balance sheets is at historic levels. I think this is a bubble. The Goodwill Bubble as I call it, will pop when firms start to realize that they overpaid for their acquisitions and begin taking impairment charges.
If these recent M&A deals turn out to be lackluster (research supports avoiding M&A activity), company EPS figures will decline due to the impairments, and therefore, a recession could be imminent. Time will tell.
Check out the HBR article about M&A history below.