Image Source: Microsoft deal presentation
Microsoft has agreed to acquire GitHub for $7.5 billion. Competing bids may have driven the price tag higher, but Microsoft’s financial flexibility remains top-notch.
By Kris Rosemann
On June 4, simulated Dividend Growth Newsletter portfolio idea Microsoft (MSFT) agreed to acquire privately-held GitHub, one of the world’s leading software development platforms, for $7.5 billion in stock. We like that Microsoft isn’t taking on more debt related to this transaction, and in light of Microsoft’s buyback program, the deal is more cash-like than anything else.
GitHub will continue to operate independently in providing an open platform for developers after the deal closes, which is expected by the end of 2018, similar to Microsoft’s course of action with LinkedIn. Companies from every industry are becoming software companies, and developers are the core of this transformation as they are the driving force behind business processes. Choices made by developers are becoming increasingly important as it relates to value creation and growth in every industry, and ownership of GitHub brings Microsoft an advantage as it is “the world’s most popular destination for open source projects and software innovation.”
Microsoft is the most active user on the GitHub platform, and management expects to accelerate enterprise adoption on GitHub via its direct sales and partner channels. The company is working to stay on top of the cloud-based software game and the growth of the “intelligent edge,” which is directly related to the Internet of Things and is described as data analysis and deployment of solutions near where data is generated, and GitHub’s presence, or its platform that enables developers, in the intelligent edge was in high demand among tech companies.
Reports have surfaced that Alphabet (GOOG, GOOGL) was also in talks with GitHub, which likely pushed the price higher. GitHub had also garnered interest from tech names such as Amazon (AMZN), and Tencent (TCEHY) in addition to Microsoft and Alphabet in recent years, and reports suggest Microsoft CEO Satya Nadella’s embracing of open-source software and programmer tools to restore growth and attract outside developers played a role in GitHub’s decision to select Microsoft from the list of suitors, in addition to the monetary consideration. The deal price implies a revenue multiple of 25x, according to reports on the private GitHub’s current run rate revenue, a hefty price tag even after considering estimates of 50% revenue growth for the company moving forward.
Microsoft will finance the acquisition with the issuance of new shares, but it is essentially a cash deal from Microsoft’s point of view as it expects incremental share repurchases, on top of its current quarterly run rate of ~$2.5 billion, to offset the stock consideration within six months after the deal’s closing. As of the end of the third quarter of fiscal 2018, Microsoft had just under $132.3 billion in cash, cash equivalents, and short-term investments compared to nearly $77.2 billion in total debt, and through nine months of the fiscal year, it is on track to easily surpass the ~$31.4 billion in free cash flow it reported in fiscal 2017.
Few companies’ balance sheets are able to take a $7.5 billion hit in stride over the course of a year or so, which is a testament to Microsoft’s financial flexibility, and Moody’s rates the deal as a credit-positive event for the company. The price tag for GitHub may be a bit hefty, but we love the business’ growth potential and what it means for Microsoft moving forward as a formidable force in cloud-based software and the intelligent edge. Microsoft certainly cannot be labeled a tech dinosaur anymore.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.