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Source link: http://archive.mises.org/16895/merger-mondays-and-malinvestment/

Merger Mondays and Malinvestment

May 11, 2011 by

When the money’s cheap, CEOs go shopping was the point I made in a talk given at the Institute’s Houston Mises Circle this January.    Despite the fact that from 60% to 80% of mergers fail,  CEOs think that when they do a deal two plus two will equal five, the fact is it often turns out that two plus two ends up equaling three.

In today’s ‘Up and Down Wall Street’ column in Barron’s, Randall W. Forsyth takes up the same theme while weighing in on Microsoft’s $8.5 billion purchase of very cool, but never made a dime, Skype.

Knut Wicksell takes center stage in Forsyth’s ‘Microsoft and Malinvestment: CEOs Gone Wild With Cheap Credit‘.

Austrians described this boom and bust cycle as the result of excess credit creation that winds up producing malinvestments that go bust. It actually was a Swedish economist of the late 19th century and early 20th century, Knut Wicksell, that saw central banks as the driver of this cycle, by lowering the market rate of interest below its “natural rate,” which drove credit expansion and pushed up prices, including those of commodities. Through this distortion of market prices for money, artificial booms occur as malinvestments are made, leading to the inevitable bust.

Forsyth goes on to explain that Ben Bernanke pooh-poohs the Austrian view. The Fed chair claims that whatever he and his charges are doing over at the Eccles Building has nothing to do with the price of Snickers or Skype.

The real damage is that these malinvestments destroy capital.  First, the price paid is often too high, and second, as professor Peter Klein explains,

as soon as the firm expands to the point where at least one external market has disappeared, however, the calculation problem exists. The difficulties become worse and worse as more and more external markets disappear, as [quoting Rothbard] “islands of noncalculable chaos swell to the proportions of masses and continents. As the area of incalculability increases, the degrees of irrationality, misallocation, loss, impoverishment, etc, become greater.”Download PDF

There’s plenty of rationalizing going on over at Microsoft, but in the end, as Forsyth explains, “they’re still malinvestments made possible by e-z and cheap credit.”


J. Murray May 11, 2011 at 9:00 am

E-Z credit is what you get when you forget the ABCs of economics (the D is the black sheep of the family, no one talks about him).

It’s a bit of a surprising article in a major publication. Only two years ago, Barrons would have outright ignored Austrian economics and fought tooth and nail that QE was a good idea. Seems that they’re noticing the results aren’t as advertised.

Mike May 11, 2011 at 9:28 am

I agree with the Mises/Austrian school’s perspective on this.

With regard to MicroSkype it should be noted that probably the major reason MSFT bought Skype was to keep it out of Google’s hands.

There is a major war going on in the hi-tech world between GOOG and MSFT. MSFT’s purchase of Skype for Cash which they have been getting a negative return on in real money terms was a smart business decision mainly because it kept Skype out of Google’s hands.

Dan May 11, 2011 at 12:34 pm

It makes sense for Microsoft to buy Skype because they can integrate it with pretty much everything they own. Of course, they could built their own Skype, but customers don’t want anything built by Microsoft (with rare exceptions). However, I don’t know if Skype was worth $8.5B.

J. Murray May 11, 2011 at 3:11 pm

Considering users are used to having it for free and it took a loss, they’ll find that to cover that loss, they’ll need a subscription plan and all those users they thought they were buying are mostly going to vanish. That or interrupt conversations with advertising, not as if that plan will be any better. Buying a company that is losing money whose sole revenue stream is not generated from the users isn’t a wise decision. Then again, Microsoft is used to wasting money on pet projects. The Xbox division is still sitting on a total loss over the past 10 years and is just recently starting to pull a profit…in time to sink a load more into R&D for the next revision.

El Tonno May 12, 2011 at 2:38 am

Microsoft Skype: How the VCs won and Ballmer overpaid


“If only Microsoft’s previous biggest acquisition, aQuantive, should have received such an outpouring of love. Having lost DoubleClick to Google, Ballmer in 2007 coughed up $6bn on diversified ads and media shop aQuantive, saying it would take Microsoft ads to the next level.

It didn’t. Despite having more employees than Skype – 2,000-plus versus 318 at last count – and more actual customers paying actual money for actual services, aQuantive got messed around with and kicked into becoming Microsoft’s advertising arm. Its staff ran – and years later, Microsoft is still making just a fraction of the online-ads money that Google rakes in.

This must have been in the back of Wall Street’s mind, too. Microsoft’s stock remained largely unmoved while the news of the largest deal in the company’s history was announced and digested on Tuesday, with shares finally trading down for the end of the day – though well under 1 per cent down.

So what exactly has Ballmer placed his faith in by spending $8.5bn in cash for a substantially smaller company than aQuantive with a less-defined business?”

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