Eat or be eaten

EVEN at charity auctions, technology titans like large transactions. At a recent fundraiser for Tipping Point, an anti-poverty charity in San Francisco, guests swiftly bid up the price for a package of Super Bowl tickets in increments of $100,000. The fortunes made by Silicon Valley entrepreneurs are so vast that the event effortlessly raised $14m. Guests tossed yellow confetti round the room in celebration.

Companies in the Valley are big spenders too. Last year around $184 billion of mergers and acquisitions were struck in the American technology industry, according to Dealogic, a research firm. There will be even more this year. This week speculation grew that Salesforce, a provider of cloud-based business software, had received several approaches—Microsoft and Oracle were said to be among those interested, though another, SAP, ruled itself out. Recent stumbles by Twitter and LinkedIn make them vulnerable; and a number of other internet firms are big enough to be an appetising prospect, but not too big to be swallowed up. Unlike, say, Google, most do not have founders with controlling stakes that could prevent a takeover.

With a current stockmarket value of $48 billion, Salesforce would not come cheap. But many of America’s biggest technology firms are rolling in money: Microsoft, for one, has $95 billion in cash and short-term investments on its balance-sheet. Among the top ten American firms with the largest cash hoards (excluding financial firms), six are technology firms, led by Apple, and they have saved up a combined $485 billion. This, plus their high share prices, gives the tech industry’s potential predators unprecedented firepower as they go hunting. Furthermore, a variety of other companies, from old-media firms to Chinese tech giants such as Alibaba and Tencent, are also scouting round the Valley with the intent of getting more familiar with American online businesses.

Although exuberance about the internet sector’s growth prospects has lifted the shares of many firms, doubts are growing about the ability of some to continue their impressive winning streaks. Recently Twitter and LinkedIn, two social networks, missed earnings forecasts, sending their shares falling by around 28% and 21% respectively. Sustained underperformance could drive down public firms’ prices and make some of them easier targets.

With a $24 billion market capitalisation (down from around $33 billion a month ago), Twitter is still a large bird to swallow; and it has been buying up smaller firms over the past few years to help it grow. However, its management has disappointed investors, who had hoped the firm would scale up faster. Unless that changes, another internet firm could swoop.

Google is the most obvious buyer. Twitter’s main problem is that advertisers still see it as a niche proposition. Google, the giant of online ads, could help solve this. The relationship between the two firms is growing closer. When Twitter reported its earnings on April 28th, it announced a partnership with Google to help it sell and measure the effectiveness of ads. Tencent, a Chinese firm that owns a popular messaging service, WeChat, may also be interested, although the American government would cringe at seeing a platform for free speech go to a Chinese owner.

Midsized, advertising-supported firms have struggled of late, as it has become clearer that some will not add users and revenues as quickly as once hoped. In other words, online advertising can be a tough business for firms “that are not named Google or Facebook”, says Brian Wieser of Pivotal Research, who studies the industry. Four firms—Google, Facebook, Baidu and Alibaba—control half of all digital advertising worldwide. Yelp, a firm that hosts online reviews and makes money from local ads, is “one of the most obvious take-out candidates,” says Mark Mahaney of RBC Capital Markets, an investment bank.

Yahoo, a darling of the late 1990s internet bubble, is a constant subject of takeover speculation. It is in the process of spinning out its lucrative investment in Alibaba, and is exploring the sale of its stake in Yahoo Japan. After that Yahoo’s chief executive, Marissa Mayer, will have run out of tricks to placate investors. Analysts and investors have urged a merger between Yahoo and AOL, another web portal, to save on costs, but one obstacle is that both Ms Mayer and Tim Armstrong, AOL’s boss, want to keep their jobs.

Yahoo, which has billions of dollars in free cash, could also be attractive to a private-equity firm, or to an old-fashioned media firm that wants to strengthen its online-video assets. Comcast, which recently dropped its bid to buy a rival cable company, Time Warner Cable, because of antitrust worries, has cash to spare and will be wondering where else to spend it.

Hunting is easier when you divide a herd. eBay and PayPal, now part of the same company, will split later this year, but how long will they stay independent? eBay’s online-auction business has lost users to other shopping websites, such as Amazon. Alibaba, which owns Taobao, a Chinese equivalent to eBay, could find it appealing. PayPal, which facilitates online transactions, could also be attractive to banks and credit-card companies, like American Express, which want to strengthen their position in mobile and online payments.

Some companies will want to expand in areas where they are already strong, the better to fight off other competitors. That may risk the wrath of regulators. “The advantage you have with the internet is that the regulatory regimes are not as aware about the dominance you can create in platforms, and therefore you can create monopolies,” says a big investor in internet stocks. Google, which has come under intense scrutiny from European regulators, may beg to differ: it may even be dissuaded from doing any big deals until the political climate improves.

Other firms will want to hedge their bets by investing in new fields unrelated to their core revenue streams. Microsoft, for example, is in the business of selling software, but it is not inconceivable that, if not Salesforce, it could buy LinkedIn, a professional social network. It is cheaper to do this early, however, before the potential of the firm or field is proved. Last year Facebook, an especially active acquirer, bought Oculus VR, a virtual-reality company, for $2 billion. Mark Zuckerberg, Facebook’s boss, was not quite sure what he would do with it, but he knew the young firm would become more valuable.

The more mature each bit of the internet business becomes, the more consolidation there will be. Mr Mahaney of RBC points to the online-travel business as an example of what might happen elsewhere, such as among the social networks. The online-travel and booking sector rose in the late 1990s, with many firms fighting it out, but in America it is now dominated by just two big firms, Priceline and Expedia.

Much of the future of dealmaking in Silicon Valley will hinge on valuations, low interest rates and the equity market’s health. Some look at Twitter’s and LinkedIn’s recent falls and wonder whether they are the “tremors before the earthquake”, in the words of a venture capitalist. So far the tectonic plates appear to have settled, and investors’ worries remain focused on specific companies that have missed targets. However, some still wonder if a big, widespread correction among internet firms is on the way. The industry’s cash-rich giants would surely relish this: what better time to strike than when prices have slumped and investors are keen to sell.

Editor's note: Since going to press, Verizon has announced on May 12th that it has agreed to buy AOL for $4.4 billion, and Yelp has put itself up for sale.