This week, we revisit Microsoft – the company that always seems to come in 2nd, and how that has worked to its advantage. If you are interested in a more in-depth discussion about Microsoft’s turnaround under Satya Nadella’s leadership, you can read about it here.

It’s good to be number two

Last year, the CEOs of four of the largest tech companies in the US (Facebook, Apple, Google, and Amazon) were summoned to testify in front of congress. They were grilled about their potential anti-competitive practices. 

From the New York Times. Source

Notice a CEO missing from this image? This guy.

Satya Nadella. Image credit to Brian Smale and Microsoft, CC BY-SA 4.0. Source

The testimony was the beginning of the global regulatory scrutiny that these tech companies experienced.

  • The scrutiny made Facebook weary of conducting M&As, and even when the company made an acquisition, it tried to keep it under a certain size to avoid notifying regulators.
  • Similarly, Google saw its M&A activities decline as it faces probes in the EU and in the US.
  • Meanwhile, in recent weeks, Apple and Google are facing regulatory push back over their app payment practices. South Korea’s parliament passed a bill that prevents large app-market operators from requiring use of their in-app purchasing systems. Similar bills to promote competitiveness are being proposed in Europe, while lawsuits are being carried out against Google in the US.
  • Amazon also faced multiple accusations of abusing its dominant market share in ecommerce and even strong-arming others to sign with AWS, a practice that Google Cloud services is increasingly adopting.

Despite being the second largest company in the S&P 500, Microsoft has largely escaped scrutiny. There appears to be a general lack of awareness of Microsoft’s dominance. Admittedly, this is hard to measure, but one proxy is the global Google search trend for “[insert the name of your tech company here] monopoly”. Microsoft consistently came in lowest when compared to others in the past 12 months.

Figure 1: Worldwide Google search trends for the phrase “[insert your tech company name here] monopoly”. Source

Why is this so? In many of the sectors that the aforementioned companies operate in, Microsoft is in #2 position:

  • Microsoft is a distant #2 in search engine market share after Google.
  • It is #2 in operating system market share (if you include both mobile and desktop platforms). Android is #1 overall, while Windows is #1 only on the desktop.
  • The company is #2 in the cloud infrastructure provider, second only to Amazon’s AWS.
  • It is also #2 in the video game console market.

Well, being #2 in multiple large markets still makes for a very large company. It’s possible that Microsoft does not get the same scrutiny because the media relatively rarely publishes negative stories about Microsoft. Afterall, unlike Facebook and Google, Microsoft’s products did not kill the ad supported traditional media business model, nor are they influencing elections.

In a recent interview, Satya Nadella framed Microsoft’s approach differently from others. Microsoft’s goal is to be a platform, not an aggregator (or a gatekeeper). And one key indicator that the platform is successful is that others can generate a much larger economic benefit from the platform. Perhaps this is why the company has largely avoided scrutiny.

Most of Microsoft’s products are tools for creation: 

  • You can use Azure (Mirosoft’s cloud infrastructure platform) to build and run your applications.
  • You can use Office 365 as your productivity suite.
  • You can use Teams to communicate and collaborate (which directly competes with Slack).
  • You can use Power BI (to do analytics and visualization) and Power Automate (to build no code applications).
  • And finally, you can use Dynamics 365 to run your sales, hiring, and other back office functions.

For the most part, Microsoft makes boring software. There are significant benefits of being #2 and flying under regulatory scrutiny.

You can continue your M&A spree unencumbered

One advantage of being under the regulatory radar is when it comes to M&As. While its peers are slowing down their M&A pace, Microsoft’s acquisition pace has been largely unchanged compared to the other companies (Figure 2).

Figure 2: Number of acquisitions of Microsoft, Apple, Facebook, Google, Amazon from 2019 – 2021 YTD

Here are some notable acquisitions:

  • In 2016, LinkedIn was acquired by Microsoft for $26.2 billion. This was Microsoft’s way to get 500 million business users’ data to be fed into Dynamics 365, specifically, into the CRM and Sales tools, enabling Microsoft’s customers to sell or hire more effectively. At the time of the acquisition, Salesforce tried hard to compete with Microsoft to acquire LinkedIn, but alas, the cost was too much for Salesforce at the time (the acquisition cost would’ve been 50% of Salesforce’s market cap at the time). Five years after the acquisition, however, Salesforce still has the highest market share in the CRM space.
  • In 2018, Microsoft bought GitHub for $7.5 billion. At the time of the purchase, GitHub was estimated to generate anywhere between $200 million to $300 million in annual revenue. Microsoft acquired the company at a 25 to 37.5x revenue multiple! Why? Was it to win developper’s good will? Maybe. Was it to change the culture of Microsoft developers to embrace open source? Possibly. Lead generation for Azure? Absolutely. Github continues to release feature sets that make it easy for developers to deploy code to Azure.
  • In 2020, Microsoft bought ZeniMax for $8 billion. ZeniMax owns Bethesda, the game studio behind the very popular Skyrim. Microsoft bought it to bolster its game streaming offering – something we discussed more extensively here.
  • Earlier this year, the company bought Nuance Communications for $19.7 billion. Nuance is the leader in voice transcription in the healthcare space. This acquisition is more about accelerating the usage of Azure into healthcare. Nuance is used by more than 55% of physicians and 75% of radiologists in the US, and used in 77% of US hospitals.

The above are just some highlights on the completed deals. In the past year, Microsoft continued to be aggressive in pursuing large deals, even if they did not pan out. It famously competed to buy TikTok and approached Pinterest for a takeover.

You can continue to bundle and leverage your distribution advantage

The fact that Microsoft has avoided regulatory scrutiny is beneficial not just on the M&A front, but also when the company bundles its products.

Twenty years ago, Microsoft battled regulators for bundling Internet Explorer with Windows. Now, the company plans to bundle Teams (its collaboration chat tool) and Skype into Windows 11, and no one is batting an eye. Even without being included in Windows 11 as default, Teams’ user growth outpaced that of Slack’s (Figure 3). This is largely because Teams is bundled into Office 365. Bundling Teams as part of Windows will only further accelerate this growth.
The inclusion of Teams in Windows is important. In an earnings call earlier this year, Satya Nadella mentioned that Teams would have the effect of increasing the usage of Office 365 and other Microsoft products – thanks to its native integration with Microsoft’s other apps. This is why Salesforce had to buy Slack.

Figure 3: Daily active user count of Teams vs. Slack. Source

Our team members at Vested may own investments in some of the aforementioned companies/assets. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for an investor’s portfolio. Note that past performance is not indicative of future returns. Investing in the stock market carries risk; the value of your investment can go up, or down, returning less than your original investment. Tax laws are subject to change and may vary depending on your circumstances.

This article is meant to be informative and not to be taken as an investment advice, and may contain certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, without limitation, estimates with respect to financial condition, market developments, and the success or lack of success of particular investments (and may include such words as “crash” or “collapse”). All are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors that could cause actual results to differ materially from projected results.

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