What Happens When Large Tech Companies Acquire Smaller Ones?

A study on what large market cap does to innovation

Photo by pine watt on Unsplash

It has been acquisition season for the gigantic technology companies for a long period of time now. Muli-trillion dollar valuations mean everything else is at a discount — especially when the major companies on the Nasdaq-100 make up 50% of the entire index.

But what happens when a larger company acquires a smaller one? Specifically, what happens if the larger company eventually deflates?

The cash loss isn’t a cash loss. Well, not cash really because the original shares sold to the public don’t directly give the company anything. However, a larger market capitalization means that you are

  1. less susceptible to takeovers.
  2. can purchase smaller companies for less stock (since your market capitalization is outrageously high).

In a way, this is a hedge against future competition and a method in killing innovation that may eventually out-innovate the industry leader.

Here is what one congressperson had to say during the technology testimony on July 29, 2020:

“Facebook has used its market power to either purchase or replicate the competition, and Facebook, Facebook Messenger, WhatsApp, Instagram are the most downloaded apps of the last decade. Your company, sir, owns them all. We have a word for that, and that word is monopoly.” — Congressman Neguse

It works on more ways than one. Even if the technology sector isn’t worth nearly as much as it is on paper currently, purchasing bloated start-ups prevents the future from competition density.

Since market capitalization is only perceived worth as a derivative of the stock price, a company using that market cap to purchase other companies can ultimately clear the future of trouble — whether that future has them deflating or stabilizing at a lower stock price.

When technology companies inevitably fall from their highs, those purchases will deflate along with them. If they are goodwill or assets put on a financial statement, they will be impaired as the future flows. These are losses in stock price, but they aren’t real except on paper. Uber purchasing Postmates for $2.65 billion might seem expensive today, but if Postmates would inevitably grow to take a significant portion of revenue from Uber, it makes sense to effectively kill it as a way to deflate the entire market.

Starting from scratch from ground zero makes sense for the larger technology companies. Taking a temporary hit to ensure you are the only player in the arena is a business plan in preservation and monopolization. Today, that business model is conflated with the world of acquisitions.

A way of killing the venture capital infusion.

Source: U.S. venture capital investment trend, number of deals and total investment amount.

In the dot-com era, most of the companies then were set out to change the world with the internet. They bled on venture capital money for long periods of time. A lot of companies were purchased for the sole purpose of being killed. Mark Cuban’s company, Audionet, is a prime example of that in Yahoo!’s $5.7 billion acquisition in 1999. Within just a few short years of Yahoo!’s acquisition, Audionet didn’t exist in any form at all.

Acquiring those companies does a few things for the larger players:

  1. Makes new venture capital money less likely to succeed as the market capitalization of the larger ones inflates. Amazon is worth about $2 trillion, Apple is worth $2 trillion, Tesla is worth as much as every automaker combined, Microsoft is worth $2 trillion, Facebook is worth almost $1 trillion, Google is worth $2 trillion.
  2. Dries up venture capital money coming in the short term, buying the most established companies more time to scale without having to spend on advertising growth through Amazon, Facebook, and Google. This is generally the time period where they can become positive in their earnings-per-share while the newer companies begin to look less lucrative.

None of this requires larger companies to be sustainable. It doesn’t matter if Facebook isn’t actually worth a trillion dollars. There is great value in providing them substantial market capitalization. And that value to them comes at the cost of actual innovation. It comes at the cost of killing competition, and the shareholder’s ideation of multi-trillion dollar internet behemoths is the sole gatekeeper for that power.

When the technology space inevitably deflates, it will take to the graveyard many of its acquisitions.

Written by

UC Berkeley, mathematics. Los Angeles. Long-time runner. Top writer on Quora, 100M+ total content views. New to Medium. Inquiries: Moumj@berkeley.edu

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