Monday, August 23, 2010

Intel purchase of McAfee - counterproductive control

Intel recently made a deal to purchase McAfee for $48/share.  A premium over $18 over McAfee's closing price, and resulted in a 70 cent, near 4%, loss for intel's share price on the day of announcement.  McAfee even at $29/share was very expensive when considering it was 24 times its earnings, with no obvious earnings growth prospects.  At $48, McAfee is valued at 45 times earnings.  Even Apple trades at 20 times earnings.

An obvious, but purely speculative, motive for Intel to make this purchase is that it is about to introduce a product that can benefit from McAfee's consumer security brand (and expertise).  We can value McAfee as two distinct entities.  Its future earning stream, and its security brand.  The future earning stream should not be worth more than 10x current earnings ($1.65B) which leaves its security brand's estimated value to intel at $6.05B. If instead of purchasing McAfee, it paid them  $363M forever each year  (license fees/ joint venture investment), then using a 6% pre-tax cost (estimated 4% after tax) alternative return on capital, the value to intel would be identical to purchasing McAfee's security brand.  It's hard to imagine McAfee refusing $363M/year for what is mostly just sitting and looking pretty for Intel, or that McAfee has key IP its competitors are unable to offer (and if so, the need to pay part of the $363M would disappear after legal protection for IP expires) .

Control of the security brand destroys its value.  A 3rd party security authority protects its brand through necessary integrity and dedication, and as we see from Intel's high offer, can reach exceptionally high intangible value.  Once cashed out, there is no reason for original organization to dedicate itself to continued excellence.  Whatever Intel "product with security enforced by McAfeee" is announced, quickly/eventually becomes diluted to "product with self-provided security."  The need for ownership control is a primal psychological delusion that transcends even society's most competent management teams, or at least compromises their duty of care for other people's (minority shareholder's) money.  Western democracies have the same authority as the monarchies and dictatorships they replaced or condemn, yet the illusion of autonomy, freedom and un-predetermined outcomes legitimizes government and reduces its security costs.

Intel shareholders, by reducing its market price by $0.70, democratically estimated that Intel overpaid for McAfee by about $4B.  If I were an Intel shareholder I would share their frustration, and agree with the approximate overpayment estimate.   Natural Finance  (QSLs prevents this abuse to shareholders by not burdening existing investors with future project decisions.

Getting back to the Intel McAfee relationship, the rational approach (for Intel) would be to identify the narrowest possible McAfee function it desires to control:  Likely some exclusive hardware license to one specific technology, and then negotiate to control that.  Both the security brand value to intel, and its investment value would be maximized.

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