Microsoft Corporation (MSFT) Buyout of LinkedIn Starting to Look Even Smarter

LinkedIn Corp (NYSE:LNKD) has registered a strong second quarter ahead of the merger with Microsoft Corporation (NASDAQ:MSFT). The proposed merger has been heavily criticized by both Wall Street and investors, and MSFT was pilloried for seemingly overpaying for the online professional networking company. But there could be good news ahead for Microsoft stock.

Microsoft stock

About a month ago, MSFT agreed to buy LinkedIn for $26.2 billion in an all-cash deal, or a sweet 50% premium for LNKD shares before news of the merger hit news feeds. This easily ranks as Microsoft’s biggest merger, and the third-largest acquisition in the tech space.

Although Microsoft’s acquisitive appetite is not in the same league as Oracle Corporation’s (NYSE:ORCL), the company certainly seems to love ’em big.

MSFT says its hand was forced in the matter by a month-long back-and-forth between it and, inc. (NYSE:CRM), which was also keen on a tie-up with LinkedIn. Microsoft said the bidding war forced it to pay at least $6 billion more than it had hoped for.

However, MSFT claims the LNKD deal is still a savvy one because the company’s Microsoft Office Productivity Suite and LinkedIn’s core database are a natural fit. LinkedIn’s users also happen to be MSFT’s core demographic. Gaining insights into the tons of user data these people throw off might help Microsoft to figure out ways to better monetize LinkedIn’s products.

Microsoft stock is up 3.6% year-to-date.

MSFT’s Spotty Acquisitions

Investors can be forgiven for feeling a bit finicky about the LNKD deal. MSFT has a checkered history when it comes to mergers and acquisitions, with many acquisitions failing to deliver the promised synergies, while others simply destroy shareholder value outright. The Nokia Corp (ADR) (NYSE:NOK) handset business, which forced Microsoft to write-off a massive $7.6 billion just a few years after the merger, remains the most spectacular in the company’s rather long list of failed acquisitions.

But Microsoft stock is up 8% since the merger was announced, a clear vote of confidence in the company’s management by investors.

A write-off of LinkedIn’s magnitude would doubtlessly leave MSFT in a huge profit hole for years, and have serious ramifications for Microsoft stock. The company has seen its profits squeezed over the last couple of years as it continues to move from an old-line software company that sells perpetual Windows licenses to a cloud subscription model. The company’s continuing success in the cloud transition has helped Microsoft stock climb 22% over the last 52 weeks.

Good News From LinkedIn

Luckily for investors, there are growing signs that LinkedIn might avoid going down that road and leave an egg on Satya Nadella’s face. LNKD just posted impressive growth for key operational metrics across key segments.

Overall revenue clocked in at $933 million, good for 31% year-over-year growth, with all key revenue categories posting strong growth. Notably, unlike peer Twitter Inc (NYSE:TWTR) whose user growth woes are well documented, LinkedIn’s membership is still expanding at a healthy clip.

Cumulative members increased 18% Y/Y to 450 million, while average monthly unique visitors grew 9% Y/Y to 106 million. Member page views grew 32%, while page views per unique visitors increased 21%, a good indication of improving user engagement.

But it was LinkedIn’s bottom line that impressed the most. LNKD’s earnings have been expanding at an admirable clip over the last couple of quarters. The company posted Non-GAAP adjusted earnings-per-share of $1.13, a robust 105% Y/Y increase and a good $0.35 above the consensus estimate. The company has beaten average earnings estimates over the last three quarters by a cumulative $0.50 per share. Meanwhile, LinkedIn’s EBITDA margin increased from 23% a year ago to 31%.

It’s commendable that LinkedIn has managed to post that kind of profit and margin expansion despite increasing spending. According to CFO Steve Sordello, “LinkedIn delivered another quarter of strong growth. We achieved record levels of operating cash flow, while continuing to invest heavily across our core member and customer value propositions.”

LinkedIn said that its product innovation and stronger enterprise offerings led to the impressive performance. LNKD’s latest results have nudged Microsoft stock higher.

Bottom Line for Microsoft Stock

LinkedIn finished with adjusted EBITDA of $292 million and non-GAAP net income of $153 million. Although a non-cash charge of $101 million led to a GAAP net loss of $119 million, that’s a one-time charge and LinkedIn appears poised to start reporting a GAAP net profit consistently. Some cost synergies brought about by the merger might help the company achieve profitability even sooner.

Additionally, investors should note that MSFT might not even have contemplated a merger during LinkedIn’s better times — LinkedIn stock was already down 40% YTD before the deal was announced.

That said, with a fast-growing top line as well as a rapidly expanding bottom line, there’s a solid chance LNKD might be able to pay for itself and Microsoft might not have to make another huge write-off a la Nokia, and it could avoid damaging investor confidence in Microsoft stock.

As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.

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