Friday, August 20, 2010

Intel's Bid For McAfee

Intel made a big splash with its offer yesterday for McAfee, the computer security/anti-virus firm.

The $7.7B deal merited two separate articles in this morning's Wall Street Journal Marketplace section, as well as the lead front-page story.

The Journal reports that the deal sports a 60% premium to McAfee's stock price. And it's Intel's largest acquisition ever.

Let's review the usual checklist governing the advisability of an acquisition like this.

First, the odds of such a combination working, knowing nothing more about the acquisition than that it is occurring, is, I believe, no more than 1 in 5.

Second, Intel is in a rather special business, with a unique culture. I've known a long-time, retired Intel multi-millionairess in the past, and her stories conveyed a most unusual business culture. It would be very surprising to me if the 'Intel way' worked with or at McAfee.

Between semiconductor boom and bust periods, heavy investment requirements, and sprawling manufacturing and design centers, Intel's core business has very different dynamics and attributes than I expect does McAfee's.

Then there's my favorite aspect of critiquing such a deal: what does owning the target provide the new owner that a close marketing or joint venture tie-up would not? This is especially relevant for firms which serve a common product/market, but aren't actually in the same product/market themselves. In this case, the intersecting product market is the personal computer/digital device. But what Intel and McAfee do is so different.

For example, consumers and, for that matter, corporate buyers, don't actually choose Intel. It's an embedded component of a larger device. But end users do often choose between McAfee and Symantec. So the focus of the two companies is very different in terms of serving users who may, or may not, choose their product.

Why couldn't Intel dedicate a business unit to working closely with McAfee, which could do the same, in order to technically knit their products and service together as closely as if they were the same firm? Even perhaps, if justified, mutually capitalize a separate entity to contract with each firm to design, manufacture and market separate, integrated products using the two parent firms' technologies?

It's one thing for Intel to allocate capital to such an effort, or just building a "McAfee Inside" line of chips. It's quite a different matter for Intel to allocate $7.7B to buy and then be responsible for managing a firm which is in a very different product space than is Intel. And managing it to achieve consistently superior total returns.

One Journal article reports,

" 'Is there a lot of downside' Probably not,' a Wall Street analyst said of the deal. 'But is there enough upside to justify the premium?' "

Just so. And a look at the nearby 5-year price chart for Intel, McAfee and the S&P500 Index shows that McAfee has been out-performing Intel and the Index for the past year, and over five years. Intel isn't even beating the Index.

So how's a firm that can't manage to be more attractive than the S&P500 going to continue McAfee's better-than-average performance? Is Paul Otellini going to suddenly become smarter in the area of anti-virus product management?

I don't think so. So there actually is some non-zero downside risk, if only because McAfee's operations could deteriorate, relatively, under Intel's new supervision.

Don't kid yourself. No operating firm spends $7.7B to keep its hands off its new toy. Maybe Warren Buffett or other portfolio investors do, but operating companies typically do not behave in that manner.

In contrast, I recently had a discussion with a retired senior oil industry executive. He pointed to the successful merger of his company and a competitor, which facilitated greater access to capital to develop the former's assets, while cutting costs. By all measures, the meger, now years old, has succeeded. But the cultures, businesses and operations were very similar, unlike the situation involving Intel and McAfee.

The Journal's in-depth piece on the deal cites Otellini as saying that McAfee will be run separately and that he's received commitments from the anti-virus firm's senior management to stay in place "for many years."

Intel shareholders should be worried about this, and this morning's drop in the firm's share price shows they well may be. It's a "damned if you do, damned if you don't" situation.

If Otellini tries to manage McAfee, he may ruin it. If he doesn't, why'd he pay a 60% premium?

See why joint ventures or very deep and close marketing relationships, in such circumstances, are less risky, but can deliver the same, or perhaps even more benefits, with less downside risk to shareholders?

Intel hasn't appeared in my equity strategy's portfolio for well over a decade. Its performance has mitigated against that. I don't think the McAfee deal will put it on a path back to consistently superior performance anytime soon.

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