Microsoft And GitHub: Why Pay With Stock?

Summary

The GitHub transaction looks expensive to many shareholders, but this is not a deal motivated by financial reasons.
Strategic in nature, GitHub furthers Microsoft's move into open-source software used to support its software development community.
The decision to pay for the deal in common stock is unusual. Microsoft could have written a $7.5 billion check for GitHub ten times over without blinking an eye.
To me, this looks like a potential means to keep important GitHub employees invested in future Microsoft success. The founders will be the largest individual stockholders behind Bill Gates.

On Monday, Microsoft (MSFT) announced it had reached an agreement to acquire GitHub, a collaborative software development platform. Widely speculated as being in the pipeline, shareholders were likely taken aback by the $7.5 billion price tag – nearly four times what the company was valued at in a July 2015 secondary funding round. Despite very explicit statements from both Microsoft CEO Satya Nadella and outgoing GitHub CEO and co-founder Chris Wanstrath that GitHub would remain independent and retain its “ethos,” GitHub users appear very cautious on the intrusion by the computing giant into what they viewed as a place safe from the pillaging hands of corporations. Retention of repositories is a major concern many have, with alternatives like GitLab and Bitbucket ready with arms open to take in any developers that flee.

The move is a predictable extension of Microsoft’s ongoing shift into open-source software used to support its software development community. It is yet another deal that highlights the continued growth of importance of cloud-based software and the Internet of Things within the technology space. Microsoft shareholders, for the most part, already understand that GitHub is not being acquired because of its financial value (the profit it can, or will, generate).

Instead, it is being bought for its platform, with Microsoft hopefully able to lure GitHub users deeper into the paid Microsoft developer environment in a tactful way that does not upset the base. Rather than financial value, this is more about strategy. Investors can draw parallels to the YouTube acquisition by Google (NASDAQ:GOOG) (GOOGL), a deal that has never made Google a dollar of profit but is widely viewed as a major success.

What I found most interesting was the decision to pay for the deal in common stock. While this is, technically, an all-stock transaction, the deal will essentially be cash funded. Microsoft is a rampant purchaser of its own shares, spending $8.359 billion gross, or nearly $2.8 billion per quarter, thus far in its fiscal 2018. There is more than $30 billion remaining on its recently re-upped buyback authorization.

In the deal announcement, Microsoft even announced an acceleration of its planned buybacks ahead of its normally quarterly run rate – dilution from the GitHub deal is expected to be fully offset within six months. The company certainly isn’t hurting for money: Microsoft held $132 billion in cash and cash equivalents on its balance sheet at the most recent quarterly close.

So why not buy out GitHub with cash? There are, after all, costs and distractions associated with running and increasing the share buyback program. It would be easier just to cut a check. GitHub was already looking for a new CEO to replace Chris Wanstrath and venture capitalists would assuredly be looking for a check – this doesn’t look to be a decision made from their end. Perhaps the answer lies in keeping core GitHub employees invested in Microsoft so they do not head for the hills after transaction close.

The deal will make billionaires out of founders PJ Hyett, Chris Wanstrath, and Tom Preston-Werner, with these three controlling roughly half of GitHub today. As this is all stock, it will make them the largest individual holders behind founder Bill Gates and well ahead of current CEO Satya Nadella. Granular details of the GitHub sale are not public, so there might be restrictions on their ability to sell shares and when.

Publicly announced, Wanstrath will be staying on as a Technical Fellow, assisting with strategic software initiatives. The role of the other two, if any, is unknown. I could understand reticence to publicly announce any relationship with Preston-Werner, who had to resign from the CEO role in 2014 following sexual harassment allegations (despite GitHub finding no evidence to support the claims).

Even to me, this seems like a speculative stretch, but I’ve got no other good reasons to point to. I’m not aware of any tax benefits from taking this approach, nor do I think that this is Microsoft speculating its stock will be cheaper to buy back a quarter or two down the line. Hopefully, investors learn more with time on the motivations behind the structure of this acquisition.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Michael Boyd wrote this article and it expresses his opinions. He said that he haven't receive compensation for it (other than from Seeking Alpha). He have no business relationship with any company whose stock is mentioned in this article.

Jun 07, 2018

About: Microsoft Corporation (MSFT)