Microsoft & TikTok – The Opportunist

This looks like an opportunistic investment for Microsoft.

• Microsoft is in talks to acquire TikTok that I suspect is more about an investment opportunity than a sudden newfound desire to have yet another go at building a consumer digital ecosystem.
• Microsoft is negotiating on two fronts to acquire the USA, Canada, Australia and New Zealand operations of TikTok in a transaction that would completely isolate the data generated from China.
• The first front that Microsoft is negotiating on is with ByteDance where the price and the IP license will be the two biggest issues.
  • IP: ByteDance started life as an AI company and the success of TikTok is largely based on its AI which is extremely good at working out what videos its users will enjoy watching.
  • Hence, if TikTok is split from its parent, it will need some form of perpetual license to ByteDance’s IP so that it can continue to have a good user experience.
  • This algorithm will also need to evolve over time and here there is quite a good fit with Microsoft which has a reasonably strong AI presence.
  • Hence, I can see a scenario where the IP is granted to the TikTok entity and then Microsoft takes over responsibility for its maintenance and evolution.
  • This will be a key negotiation point because these sorts of algorithms require vast amounts of data to be effectively trained which is exactly what the fuss surrounding TikTok is about.
  • Hence, a key risk of this acquisition will be Microsoft’s ability to maintain the TikTok algorithm to the standard that ByteDance has been able to do it.
  • Price: Faced with the prospect of being shut down in the USA, Canada, Australia and New Zealand in addition to India, has put ByteDance in a weaker negotiating position.
  • If its business is permanently blocked in these countries, then its assets there have no value.
  • Hence, Microsoft will be able to achieve a meaningfully lower price than if it simply purchased the unit from ByteDance under normal circumstances.
• The second front Microsoft is negotiating on is with the US government where it is shuttling back and forth to come up with a structure that will see the deal approved as well as be palatable to ByteDance.
• The real question to be answered though is why would Microsoft want to buy TikTok given that it is a consumer app but Microsoft has almost completely shifted to the enterprise following Nadella’s elevation to become CEO?
• There are two factors to consider:
  • First, Minecraft and Xbox: Over the last few years, both of these businesses have looked increasingly vestigial to Microsoft which is why I have maintained that Microsoft would probably divest them if someone made a good enough offer.
  • TikTok is a partial fit with Minecraft given that the user base is of both are very similar meaning that there will be a large overlap.
  • How this can be leveraged to Microsoft’s advantage is very unclear (beyond running the whole service on Azure) and so I think that this is not the main motivation.
  • Second, Financial investment: remains the most rational reason for Microsoft to purchase TikTok in my opinion.
  • Microsoft is not in the crosshairs of the current backlash against big tech which means that it is in a position to make this acquisition much more than Google or Facebook are.
  • The fact that TikTok is at risk of a complete shutdown means that Microsoft will be able to get a better price than in normal circumstances.
  • Hence, it could purchase the asset, migrate the backend to Azure, ensure the roadmap of the algorithm and begin monetisation.
  • Once this has been achieved, Microsoft could IPO the unit (potentially along with Minecraft and Xbox) and earn a healthy return.
  • A sale to private equity would also be a possible exit.
  • It would also have the benefit of gaining a cornerstone client for Azure which may help it gain share in the digital consumer segment.
  • Azure to date has had the most success with B2B which is not a surprise given its heritage, its recent shift away from consumer and the makeup of its salesforce.
• Consequently, I see this as an opportunistic acquisition for Microsoft and one where, with the right execution, could earn a handsome return for shareholders.
• I don’t see Microsoft having another crack at a digital ecosystem as this has already been tried and was something that its CEO was dead against when he took over.
• Nadella is a sensible and pragmatic leader and I see no reason whatsoever for him to have changed his mind.