When patient money is big money

By Felix Salmon
January 14, 2014

As a private company, we have concentrated on the long term, and this has served us well. As a public company, we will do the same…

If opportunities arise that might cause us to sacrifice short term results but are in the best long term interest of our shareholders, we will take those opportunities. We will have the fortitude to do this. We would request that our shareholders take the long term view.

With these words, Google went public in 2004 — and they have, since then, been true to their word. They have not been maximizing short-term profits; neither have they been stinting on long-term investments, especially in projects like the self-driving car which might not pay dividends for a decade or more. Today, Google spent $3.2 billion to acquire Nest. Once again, they’re investing for the long term.

On the same day, Suntory spent even more money — a whopping $13.6 billion in cash, plus another $2.4 billion in assumed debt — to buy Beam, a coveted whiskey company. Suntory doesn’t need to worry about what its public shareholders think, because it doesn’t have any. It’s privately held, and can spend its money on anything it likes, while keeping an eye on long-term value rather than short-term profits.

Neither of these acquisitions makes sense if you approach them wielding earnings multiples or net present value calculations. I very much doubt that Nest has made a penny of profit in its entire existence, and the acquisition price works out at roughly $2,900 per Nest-boasting home, based on estimates that there are 1.1 million such homes. Meanwhile, Beam sold for 20.5 times ebitda, and 6.4 times revenue. And it’s not like some huge revenue boost is around the corner: the sale price even works out at 5.3 times estimated 2016 revenue. Neither of these deals are going to pay for themselves any time soon.

But that doesn’t mean that they’re bad deals. Both of them are attempts to, quite literally, buy the future. The case of Nest is pretty obvious: it’s the foremost company in the hot Internet of Things space, and in its short life has already built up a valuable and much-loved brand. Its products are expensive, but they’re very good-looking, and the user experience is fantastic. Nest is basically the OXO of internet-connected household gewgaws, and if it were to release a lightbulb, I’d buy dozens of the things in a heartbeat. Similarly if it offered to replace my alarm system.

Google is drowning in cash: it has more than $58 billion to spend, so this acquisition barely makes a dent in the company’s war chest. And if the price is high, it is also ratified by the market: Nest would have had no difficulty raising hundreds of millions of dollars in new equity at a $3.2 billion valuation or even higher. Most excitingly for Google, it has now poached dozens of former Apple employees, all of whom understand how to design great consumer hardware in a way that Google clearly doesn’t. If just a little of that magic rubs off onto, say, Motorola, that could justify the acquisition price right there.

Meanwhile, from Nest’s point of view, this deal gives the company room to concentrate on developing great products, without being distracted by corporate affairs, patent wars, and the like. Google’s lawyers can now deal with all of Nest’s legal and licensing headaches, and Google’s lawyers are not only very good but also have very deep pockets.

The Beam acquisition is also at heart about brand value: Jim Beam, Maker’s Mark, Laphroaig, Courvoisier, Sauza — these are resonant, deeply valuable brands, and they’re brands which are only going to rise in value over the long term. Bourbon, in particular, is an incredibly hard market to break into, thanks to the many years it needs to spend in barrel before it’s bottled. Beam’s revenues are being artificially constrained, right now, by the fact that it can’t sell more bourbon than it made seven years ago. But it has been ramping up production of late, and will surely continue to do so now it’s owned by Suntory: the Asian market in general, and China in particular, is potentially almost unlimited.

In other words, Suntory isn’t spending some multiple of 2013 earnings, or even 2016 earnings: it’s looking to the 2020s and beyond, and it’s betting that no matter how much it pays now, it’s more than worth it for the advantage of being the first Asian company to own a major bourbon brand, in a world where demand for bourbon is sure to continue to rise inexorably.

The Suntory deal is similar to the Google deal in another way, too: neither company values balance-sheet cash particularly highly. In Google’s case that’s just because the company has so much of it; in Suntory’s case that’s because Japan is — still — stuck in a liquidity trap. A Japanese company with cash is a bit like an American traveler with frequent-flier miles: it’s always a good idea to spend today, because the currency will be of less use to you tomorrow.

There aren’t all that many companies out there which are dominant in spaces which are clearly going to be huge tomorrow, be they the Internet of Things or bourbon. So we’re not going to see a lot more takeovers at these eye-popping valuations. But if there’s one big lesson to be drawn from today’s M&A activity, it’s that there’s still serious amounts of strategic cash on the sidelines if the right target comes along. As Charter’s $37.3 billion bid for Time Warner Cable proves.

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Comments
9 comments so far

“Neither of these deals are going to pay for themselves any time soon. But that doesn’t mean that they’re bad deals.”

-actually Felix that’s literately the very definition of a bad deal.

You could make a weak case that NEST has so much growth potential that you can pay the almost infinity metrics on sales and earnings today because in 10 years the market for connected controls will be 100x what it is today… good luck with that… but at least that’s something.

In the case of BEAM you stated quite accurately that it will be the end of the decade before they have any real capacity growth… and for that capacity constrained company to pay 20x EBITDA… in the immortal words of Kid Dynimite… sold to you sucka!

Posted by y2kurtus1 | Report as abusive

y2k, are you saying all deals must have short term results? That any investment that doesn’t have quick return is a bad one? If that’s the case, then there are lots of things that should never be done – mass transit systems, airplanes, long distance fiber networks, Amazon, etc., and most new companies.

Posted by KenG_CA | Report as abusive

I get the sense that y2k does not believe in R&D.

Posted by GRRR | Report as abusive

Felix, if you want to replace your alarm system you don’t have to wait for Nest. Check out Vivint.

http://www.vivint.com/en/

Posted by Asgardian | Report as abusive

KenG, the problem is the tyranny of the Net Present Value calculation. Beyond 5 years or so, the present value of future cashflows drops to zero. Think about this: it effectively says long term relationships with, say, good, high value customers are worthless.

http://en.wikipedia.org/wiki/Net_present _value#History

Another reason to be thankful for modern ‘finance’!

Posted by crocodilechuck | Report as abusive

“Beam’s revenues are being artificially constrained, right now, by the fact that it can’t sell more bourbon than it made seven years ago.”

In what sense is this constraint “artificial”? I would have thought that not being able to sell something you don’t have to be quite natural. All the terribly clever ways to work around this strike me as meriting the characterization of “artificial.”

Posted by rrhersh | Report as abusive

Asgardian, Vivint is typical of Nest competitors – they want to make their money on monthly fees. Most home automation providers believe that tens of millions of consumers will pay $30-40/mo for a service that is worth maybe $0.25/mo. They want to sell you hardware, and then provide a portal to access it, as if that’s some valuable service. Nest and Google realize that most people won’t pay that, or even $10/mo, and will find other ways to make money. When those companies fail (and most will) their investors will wonder where they went wrong, without considering the fact they were delusional.

chuck, I get what you’re saying, but if money is just sitting in a bank doing nothing, as most hordes of accumulated profits do, then their net present value is zero. Cash only has value if you are willing to use it.

Posted by KenG_CA | Report as abusive

R&D the way IBM, or Intel, or TXN, does it is probably fine… innovation leading to patents leading to marketable goods and services. Those company have a history of earning a return on R&D spending. General Motors not so much, I remember the commercials about how they were pouring money into biodegradable soy based seat cushion foam, the fuel cells ect.

For a company to spend money on R&D their needs to be a goal of a viable product or service within a 10-year window… I don’t think that would be a controversial statement even at the most innovative companies like AAPL or Nest.

Posted by y2kurtus1 | Report as abusive

Google is a perfect example of a company who takes a long view, amid the most recent acquisitions: Boston Dynamics and Nest. But that´s not the whole story, not by far. As every other big company, Google is constantly facing competition from medium and little companies, most of all startups. The problem lays over the asumption that nobody can foresee the future, accordingly, a small company can disrupt the market and leave a giant like Google out of business. That´s why these giants constantly buy small companies, mainly out of fear that their businesses could be in jeopardy, and not because they intend to develop any new strategy or a long term view prevails. Nest and Boston Dynamics appear on the news because, among other things, they were not cheap, but a closer look into all the companies that Google buys reveals a completely new approach, just last year Google bought 21 companies and none of them were on the news. I have doubts that a big strategy was put in place for each one. So yes, Google takes the future very serious and have made interesting and long term investments, but the facts prove patience is not always the way to go.

Posted by jonathanstahl | Report as abusive
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