Story updated to clarify Yacktman Fund's purchase of eBay stock in 2007.
) -- Fund manager Jason Subotky saw a headline late Monday that
was moving to buy communications-software company
for $8 billion in cash. His initial reaction: "not thrilled," he said.
Subotky, who helps manage the
, says that given the history of Microsoft's management, which failed spectacularly in a bid to acquire
in 2008, the Skype deal is the software company's latest head-scratcher.
Justifying the purchase price is even harder. At $8.5 billion -- the total given in a release today -- Microsoft is paying 85 times the $100 million Skype had filed to raise in its initial public offering. It was only two years ago that Microsoft was set to pay $44 billion for Yahoo, which now has a market value of $24 billion.
"It remains to be seen, but it's going to be very hard, in our opinion, to be a good justification for the price that was paid," Subotky says from his office in Austin, Texas. "The valuation seems extraordinarily high, but it's a very small deal. We would prefer Microsoft do other things with their capital over time."
Subotky and the other managers of the Yacktman Fund have a good idea about Skype's value, as the fund held a large position in
in 2007, two years after the online-auction site bought the communications company for more than $2.5 billion. "It's an astonishing jump in valuation," Subotky says.
Subotky notes that Skype is based in Luxembourg, and he assumes Microsoft tapped overseas cash for the deal. If so, that would make the transaction not as expensive as it appears, as Microsoft would not have to pay repatriation taxes.
In addition, if Microsoft believes the purchase of Skype will create higher earnings, that makes the deal more productive than holding on to cash. By stripping unproductive cash off the balance sheet by using overseas cash in the purchase, Microsoft can better justify the high price it paid for Skype.
"That was likely a driving force in the higher valuation," Subotky says. "But they paid a high multiple, and Microsoft still has damage to repair from their aggressive attempt at Yahoo, which fortunately failed. This makes people question their discipline. Shareholders would've liked to have seen Microsoft buy its own shares. Buy more of what you know at a low multiple."
Initial headlines on the deal noted how the purchase of Skype would be the largest purchase Microsoft has ever completed. But Subotky argues that the amount is a drop in the bucket for Microsoft. As of the company's last quarterly earnings release in April, Microsoft had $50 billion in cash and short-term assets. Microsoft's cash position accounts for 17% of its market cap of $217 billion.
"If it's a transformative deal or a very large deal, you can destroy a lot of value in a hurry," Subotky says. "But when you're spending 4% of your market value and less than 20% of your cash, it's not a major milestone. It's the biggest deal they've done in their history from a nominal dollar size, but it's a very small deal."
Because the transaction is small in relation to Microsoft's size, Subotky says the Skype acquisition doesn't change the fund's thesis on Microsoft. The Yacktman Fund counts Microsoft as its fourth-largest holding as of March 31, with a 4.9% weighting, behind only
Procter & Gamble
, which won
TheStreet's 2011 Best Mutual Fund
award for the
category, returned an annual average of 14.5% in the three years through April 30, even though the broader stock market plummeted almost 40% in 2008. By minimizing risk, the portfolio managers navigated the sharp downturns in 2008 and 2002, outperforming the broader market.
Valuation is a bright spot for Microsoft, with a forward price-to-earnings ratio of less than 10, well below the current market multiple. While the low P/E multiple makes Microsoft a top pick for value investors, the idea that the company may have overpaid for Skype leaves Subotky scratching his head.
"We certainly never like when you have a very low multiple stock involved in paying a high multiple for something," Subotky says.
With Microsoft's stock down 2% on a day when the broader market is trading higher, it appears investors in the software company aren't thrilled with the $8.5 billion deal either. Microsoft shares are now down nearly 8% this year, as the
has climbed 7%. As of now, Subotky says he's not sure he'd be adding to the fund's position on the decline in share price.
"We have a big Microsoft position, and we'll evaluate it," he says. "The market's reaction is fair, but the stock is very cheap."
-- Written by Robert Holmes in Boston
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