Why would Microsoft, a software company that has achieved global dominance through writing proprietary software, spend $7.5 billion on GitHub, a company dedicated to building up a world-beating repository of open-source alternatives? Are they buying it to kill it, a bit like the National Enquirer allegedly did with those tales of Donald Trump’s infidelities?
Not at all: Microsoft is the ideal home for GitHub, and the hefty price tag is merely a sign of how seriously Microsoft CEO Satya Nadella takes GitHub’s mission. Companies can be worth a lot more to a strategic acquirer than they would be on the open market, and GitHub is a prime example.
In that sense, it’s similar to Pret a Manger, the sandwich chain that was sold last week to the wealthy Reimann family for some 1.5 billion pounds. That’s a substantial premium not only to the 345 million pounds private equity firm Bridgepoint bought it for in 2008, but also to the amount that Pret would be worth as a stand-alone company on the stock market.
So what’s going on here? How can GitHub—a money-losing tech company that hasn’t had a CEO in 10 months—possibly be worth $7.5 billion to anybody? And how can a sandwich chain be worth $2 billion to a German family business?
The fact is, there is a logic here. In both cases, the buyer was looking beyond the kind of valuation metrics that get taught in business school, and in both cases the final price negotiated was significantly greater than the public valuation that could have been expected in the wake of a stock-market listing. And while in many cases it’s bad for an acquirer to overpay for an asset, in both of these cases the multibillion-dollar valuation is a very good sign for the companies, their employees, and their customers.
For Pret a Manger and GitHub both, what is being bought is not a set of cash flows, or a profit opportunity: It’s something both less tangible and more valuable. The secretive billionaire Reimann family is adding Pret to a formidable portfolio that already includes Au Bon Pain, Panera Bread, Krispy Kreme, Dr Pepper, and Snapple, alongside a coffee operation that spans Keurig, Peet’s, Intelligentsia, and Stumptown.
The strategy here is clear. As the global middle class expands, it’s going to demand ever-growing quantities of fast, convenient, high-quality food and drink. If you buy the best brands in that space, you’re going to be very well positioned, on a multigenerational time horizon. The Reimanns neither need nor want large profits today; what they’re building, instead, is an empire designed to support their great-great-grandchildren. The upfront cost is a sign of the depth of their commitment, in part because it effectively precludes flipping the franchise at a profit. The Reimanns, in other words, are here for the very long term.
That’s a significantly different stance from the public stock markets, which ostensibly provide permanent capital for companies. The problem there is that while the capital might be permanent, the share price isn’t, and shareholders tend to want to see the share price going up and to the right. To that end, they’re constantly looking for earnings growth, meaning higher profits every year. The markets obsess about things like “same-store sales,” which is the annual growth in the amount of money any given store can make. If that number starts looking stagnant, the markets worry and knock your share price down, and make you vulnerable to hostile takeover bids.
The Reimanns, by contrast, are not going to be sweating per-store sales growth at Pret, because they’re building a brand, not a cash flow machine. Think about the family store your grandfather, or someone else’s grandfather, might have owned: If it afforded him a decent income, year-in and year-out, which rose along with inflation, then that would be exactly what the family needed.
As for GitHub, it’s just the latest in a string of major Microsoft acquisitions (Skype, Minecraft, LinkedIn) that seek to move the company away from Windows and toward a much broader set of services for people using any kind of device. This time, really, the profits don’t matter: Microsoft is paying by issuing about 73 million new shares of stock, which cost it nothing. (It’s a tiny dilution, given the company’s 7.7 billion shares outstanding; what’s more, the share price rose on the news, which means that existing shareholders are happy to be diluted.)
GitHub is not being bought for its revenues, but rather for the promise (a promise not everyone is convinced can be realized) that it will be able to turn Microsoft into an even more developer-friendly place than it already is. No more will GitHub’s managers need to worry about how their new CEO is going to lead them to profitability. Instead, they can concentrate on simply providing the very best service to their customers, who will end up spending dozens of hours a month inside the Microsoft ecosystem. For the Redmond, Washington, giant, that’s priceless—and all at a price much less than it would cost to, say, buy Red Hat, another open-source darling that currently has a market capitalization north of $30 billion.
The fact is that in these cash-flooded times, it’s trivial for the Reimanns to come up with $2 billion, or for Microsoft to issue $7.5 billion in stock. The upfront purchase price is really the easy bit. What’s hard is finding brands and assets that can thrive for decades or more in a fast-changing world. When one of those comes along, there is almost no price too high.