Strategic Denial Doesn’t Make Sense of Crazy Acquisition Prices

Lydia DePillis tries to sketch a theory of sky-high acquisition prices for unproven tech companies:

“Facebook says ‘Crap, If Google buys Instagram, they have a great photo sharing app, photo sharing is what a lot of people use Facebook for these days, all of a sudden Google Plus becomes relevant, and we can’t let that happen,’” Aberman summarizes. “‘So we’ve got to get in there and buy it, and we will pay a ridiculous number if we have to, because we’re spending funny money anyway.’” 

Viewed through this lens, a lot of other eye-popping price tags—like Yahoo!’s $30 million acquisition of a 17-year-old’s news aggregation app—start to make more sense. Even if Yahoo! never fully monetizes the service, it’s worth the cash to prevent someone else from doing so. In 2011, the latest year for which comprehensive figures are available, Google spent nearly $2 billion on acquisitions, Amazon spent $771 million, and Apple spent at least $776 million. Sometimes it’s not even about the product so much as the people who invented it: Big web companies often buy whole companies just for their talent. Who knows what damage they could do if they went to a competitor? 

Call this the “strategic denial” rationale for a high-dollar acquisition. You hear it a lot, and this is clearly on the minds of people in the tech world. But it doesn’t really make sense. After all, if you don’t actually want to own Instagram and just want to avoid a scenario in which Google acquires it, why not pay Instagram to agree not to join forces with Google? Unless Instagram’s owners are insane, they’d sign a contract to that effect for less money than they demanded to actually let Facebook own the whole company. Plus you could team up with other firms that share your interest in strategic denial—form a consortium of firms that want to bribe Instagram to avoid selling itself to Google.

I think the real answer to why big tech companies spend so much on acquisitions is that they’re actually not spending very much on acquisitions. Google had $35 billion in cash on its balance sheet in 2010. That rose to $45 billion by 2011 and $48 billion by 2012. That’s a big and rapidly growing pile of cash at the company that’s been the most aggressive at acquiring companies. Cash is an extraordinarily unlucrative thing to be invested in these days. It earns a negative real return. But if you don’t want to hold cash, you have to invest in something. So you invest it in buying companies, acquiring their talent and intellectual property and user base and whatever else.

Long story short, it may sound like these companies are spending a lot of money. But the relevant issue is opportunity costs. What is Apple giving up when it spends $776 million on acquisitions? The answer is: nothing. Apple isn’t hurting for cash. Neither is Google. In many ways the real question is why these companies aren’t going on bigger spending sprees?