Because the reality is that 65 percent or more of mergers and acquisitions fail to achieve their stated financial and operational targets. All too often, the highly touted bridge to the future becomes a boulevard of broken dreams. That's why.
When Yahoo's purchase of Tumblr and its 175 employees for $1.1 billion was announced, it was Marissa Mayer, CEO of Yahoo and the reigning Queen of Tech who promised not to screw it up. That seems to have played well to the digerati.
But it belies some of the very real problems the acquired company already faced, even before it had to begin dealing with the melding of cultures, natural resentment of the acquired for the acquiring (and vice versa), the mixing of often incompatible systems, the imposition of new accounting, marketing and human resource policies and the host of other PMI (post-merger integration) issues that every commercial combination must worth through. In this case, those new management challenges are being larded on top of existing marketing and profitability issues that may have prompted the willingness to sell in the first place.
Given the hurdles that such complicated financial, managerial and interpersonal initiatives usually entail, the promise to not screw it up may not be the ringing call to arms and lofty embrace of the future that everyone from employees to customers to investors may want to hear, but it may be as good as it gets. JL
Peter Cohan reports in Forbes:
Karp has done well for a seller in trouble. According to the Times, Tumblr burned through $25 million in 2012 and Facebook, Microsoft and Google, all turned down Karp’s offer to sell after he had trouble adding to Tumblr’s $125 million in cumulative venture capital.
Yahoo will buy New York City-based blogging service, Tumblr, for $1.1 billion. This is bad news for Yahoo shareholders because the deal fails the four tests of a successful acquisition.
Tumblr — founded by high school dropout, David Karp, in 2007 and now employing 175 – claims 108 million blogs that Quantcast reports reach 44 million U.S. citizens and 134 million people globally, according to the New York Times.
Tumblr’s efforts to generate revenue through “interactive campaigns, rather than standard clickable ads” fell way short of expectations. Tumblr generated only $13 million in 2012 revenues and $13 million in the first quarter of 2013 — with a goal for this year of $100 million.
But the deal will enrich Tumblr’s biggest shareholders. Karp owns nearly 25% of the company and will get about $250 million from the deal, according to the Times. Meanwhile, Boston-based, Spark Capital, whose founder, Todd Dagres I interviewed a few weeks ago, participated in five Tumblr financing rounds and Spark ”is expected to make tens of millions of dollars from the deal.”
Will Yahoo shareholders make money from this deal? My research on acquisitions suggests that most of them fail because they do not pass four tests of a successful acquisition. Here’s why Yahoo flunks each of those four tests.
1. Tumblr’s industry is not attractive
The first test of a successful acquisition is that the industry in which it competes is profitable — ideally more profitable than the industry in which the acquiring company participates.
Tumblr’s industry of interactive advertising is less profitable than Yahoo’s display advertising industry. For example, Yahoo’s return on equity over the last five years averaged 11.9%. Tumblr lost about $2 for every dollar of revenue it earned last year, so it is clearly losing money.
Whether its brand of interactive advertising could potentially become profitable is subject to speculation but based on Tumblr’s inability to come to terms with Facebook, Microsoft and Google my guess is that they do not see an attractive industry here.
2. Combined companies are worse off
The second test of a successful acquisition is that the combined companies will be better off after the deal. This can be measured by whether the combined market share of the companies is higher and whether the combination strengthens the capabilities needed to prevail in the industry.
While the deal will boost Yahoo’s market share fractionally, it is unclear whether the combined companies will have stronger capabilities. Yahoo has 700 million users and 8.4% of the digital advertising market — down from 15.5% in 2009, according to eMarketer. Tumblr’s $13 million in revenues are a dust smidgen compared to Yahoo’s roughly $5 billion in revenue.
To be sure, Tumblr would boost Yahoo’s mobile rank. App Annie ranks Tumblr 63rd among iPhone apps in the U.S. — ahead of all Yahoo apps. And on Android smartphones, App Annie ranks Tumblr 85th — Yahoo has one app, Yahoo Mail, that’s higher on Android.
But the bigger problem for the combination is that when it comes to winning in the online advertising business, neither Yahoo nor Tumblr has figured out how gain market share. Yahoo has lost a huge share of the online advertising market to Google in the last three years.
So combining with Tumblr — even less capable of monetizing users — will do nothing to make Yahoo able to compete with Google. To regain its lost market share, Yahoo must be better than Google at attracting users and selling them advertising that generates a return on investment for the companies trying to reach those users.
Even achieving Tumblr’s modest revenue goals requires skills that both companies lack. One reason for this is that bloggers own their Tumblr pages which means that to advertise on them, Yahoo will need to get the bloggers permission, place an advertisement there, share the revenue with the blogger, and persuade an advertiser that this advertisement will be worth buying, according to Fortune’s John Saroff.
3. Yahoo is over-paying
The third test of a successful acquisition is that the buyer pays less than the present value of the target’s future cash flows.
Yahoo appears to have failed that test because it is hard to see why a service that burned through $25 million in cash last year can generate enough positive cash flow to justify paying $1.1 billion of Yahoo’s cash.
One analyst who came up with a possible justification for the price is Saroff who estimated that Tumblr could generate $108 million in annual revenue. He sees a conservative scenario in which revenues would pay for the deal in under 10 years. As he wrote, “If we assume no growth and no international, [Tumblr's 60 billion in annual pages views] will spin off $108 million per year if a net $1.79 revenue per thousand pageviews is achieved.”
I doubt whether that is achievable and will yield sufficient cash flow to repay Yahoo shareholders. After all, Tumblr has only succeeded in generating about a tenth of that $108 million — this may be due to two factors: it hosts plenty of content that is not suitable for advertising and advertising could cost Tumblr many of its users.
4. Yahoo will struggle to integrate Tumblr
The final test of a successful acquisition is whether the acquirer can integrate the target company. This means making sure that the roles and responsibilities of the target’s people are defined clearly and that they are so well tied into the acquirer’s systems and culture that the acquisition is seamless to the target’s customers.
There are a few problems that Yahoo will face when it come to integrating Tumblr. For example, Karp has resisted display advertising on Tumblr, reports Fortune. This suggests a potential conflict if Yahoo keeps Karp in charge and requires him to push display advertising onto Tumblr’s customers.
Customers may bolt as well. According to Time, TechCrunch’s co-editor, Alexia Tsotsis, told a colleague that Tumblr is part of her identity and “for whatever reason, I don’t want to identify with Yahoo.”
When Yahoo’s board hired first-time CEO, Marissa Mayer, it probably thought she would go through a learning curve. But the $1.1 billion Tumblr deal is Yahoo shareholders’ most expensive tuition payment yet.
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