In a previous job we regularly held ‘crazy idea’ sessions, in which one person had to research a potential M&A target and walk through the rationale about the acquisition for both sides of the transaction (acquirer and seller). Obviously, most ideas went nowhere, but I am satisfied that I got one or two correctly.
And because the end of the year marks that time of the year when people write about the best [anything] of the year and predictions of what lies ahead, I decided to carve out a new type of prediction: crazy M&A ideas.
I) Will Apple (AAPL) Entertain an Acquisition of Peloton (PTON)?
It has been noted time and again the power of Apple’s unified environment that spans to music, computers, phones, and watches. It simultaneously makes syncing data between them easily and making it more inconvenient to share outside, resulting in engaged users. The ‘fitness and health’ category was the next iteration when it launched the Watch in 2015, and shortly after that added many now popular fitness-oriented features such as Mindfulness and Heart Rate to complete the omnipresent ‘Close Your Rings’ family and friends’ competitions.
In 2020, with the Apple Fitness+ subscription service, Apple chose to lock-in fitness around the Apple Watch to control and track workouts — from cardio to cycling to yoga — copying the iPhone playbook: hardware is the foundation and software is the roundup. With increasing new sensor capabilities, the watch can better educate their users about their health, and software delivers more use cases with an ever-expanding library of content and apps (generated by Apple or by thrid-party).
So why would Apple entertain this acquisition? The response goes back to hardware and software and how integrated businesses work:
Vertically Integrated Businesses are difficult to succeed for their different sets of expertise and cash requirements: Hardware tends to be driven by long and structured waterfall development cycles and is cash intensive by nature: heavy upfront capex investments to match long-term customer demand, followed by complex manufacturing and logistics steps. Economics are based on variable and marginal costs.
On the other side, As Marc Andreesen put it elegantly: “software is our modern alchemy” and is a “lever on the real world”: software is built in short development cycles that relies heavily on testing and customer feedback. As a result, cash is less of a constraint since it is primarily based on the size of the development team.
The challenge is to merge these two distinctive sets of capabilities into one coherent organization. For those few who are able to successfully integrate, there are several key long-term benefits:
* A tight integration tends to improve customer experience (which in turn lead to high Net Promoter Score and is a strong predictor of customer loyalty): In the case of Peloton, users make more than 20 monthly workouts (240 per year), significantly better than the average gym member who visit their location nearly 9 times a month (104 per year). This leads to predictable revenue growth and profitability profile. Peloton’s Connected Fitness Products have Gross Margins in the 10–15%, whereas it’s subscription posts 65% Gross Margin.
Another item in this M&A idea relates to supply chain synergies: We all learned that supply chains are facing a once-in-a-lifetime battle. There are port congestions, the Suez Canal obstruction (who remembers that anyways) and containers pilling across the world.
What we all agree, though, is how world-class Apple’s supply-chain is: From a tight control of suppliers to excellent inventory turnover (it posted less than 10 days of inventory turnover for most of the past decade), it is said that Apple has a tremendous ability to forecast, and timely deliver the products that customers crave.
The world also is aware on how unpredictable Peloton’s supply chain has been during it’s fast-growth phase: From its $1 billion spent in supply-chain related initiatives in 2021 to CEO writing open letters to address their delays.
“These unpredictable delays have resulted in painful delivery reschedules for many people as Peloton Bikes, Treads, and accessories have been held at Port for upwards of five times longer than usual”
On its most-recent quarterly results, the company disclosed that its Connected Fitness Product Gross Profit declined by 75% year-over-year, with Gross Margin dropping from 39.4% to 12%, and it forecasts Margins of 7% for the next quarter, driven primarily by supply chain costs and unrelated change in product mix.
The magnitude of the opportunity cost for Peloton is massive: From lower bike deliveries and higher supply-chain costs, Peloton have opportunity costs that ranges anywhere between $500m and $1.5billion, depending on the duration of the supply chain crunch and justifying the related $1 billion initiative.
Likelihood: Nearly Impossible. Here is why:
* It would be the most expensive acquisition in Apple’s long history of small acqui-hires;
* The company is not in the apparel industry, an area in which Peloton is actively focusing;
* In-house manufacturing: Peloton acquired Precore for $420m primarily for its in-house manufacturing capability, which is the exact opposite as to what Tim Cook was brough in to Apple in the first place:
“When Cook initially took over Apple’s supply chain, he cut down the number of component suppliers from 100 to 24, forcing companies to compete for Apple’s business. He also shut down 10 of the 19 Apple warehouses to limit overstocking, and by September of 1998 inventory was down from a month to only six days”
The counter-argument is that Precore’s acquisition is in fact very similar to Cook’s approach: Peloton struggled to match supply and demand of their connected fitness devices and wanted to streamline the number of suppliers. I’ll leave it up to the reader to decide which side of the coin is correct.
*The whole GymKit API fight between the companies.
Nonetheless, I bet Apple has a pdf from an Investment Banker who pitched this idea multiple times in the last 5 years.
II) Tesla (TSLA) Should Merge With SpaceX, The Boring Co and Neuralink, to Create the 42069 Holding.
Will this be the meme king that we all need in a ‘normal’ 2022?
Likelihood: anywhere between 4.20% and 69%
III) Will Meta Buy Klarna Now And Pay Later?
Buy Now, Pay Later (BNPL, or pay-over-time) is here to stay. According to the great Justine Moore, this has become one of the preferred payment methods for Gen Z and Millennials for its ability to defer upfront costs into smaller installments. It can be used for high value purchases (from airplane tickets to stationary bikes) and small ones (clothes and accessories). It represents approximately 2% of the total $10 trillion in global online payments, but it is the fastest-growing payment category across the world.
BNPL companies don’t typically charge consumers, but instead the merchants either through interest fees arrangements or transaction fees that can be lower than traditional credit card operators. But the real value of a BNPL lies in its network effects: The greater the number of active users and the greater the number of active merchants, the greater the value of the network will be.
Merchants say that adopting BNPL alternatives improve online conversion rates, increase repeat purchase patterns and that customers have higher average order values. For customers, this payment solution is a unique product discovery platform, it has less stringent credit controls (which can be good and bad) and it is considered a more modern mobile payment solution (See here and here for more details).
Also, one can understand market dynamics by looking at investor presentations. This is how Afterpay presents the value of its network:
And this is Affirm’s take:
Therefore, the industry is facing fierce competition to lock-in active (and good credit) users, as well as the most relevant merchants. And the ‘smart money’ is following this consumer behavior: There have been at least six relevant M&A deals in the space over the last twelve months, including the deals from Square (Afterpay for $29 billion) and PayPal (Paidy for 2.7 billion just one month after Square).
The market grants a premium in Enterprise Value over Number of Users for Affirm for *only* two reasons: Shopify and Amazon. It is the exclusive BNPL provider for the former and has exclusivity agreements with the latter (with side ownership agreements for both companies to own a piece of the firm). Afterpay was acquired with similar comparable metrics to Affirm, and one can assume that Square (now Block) expects to generate significant revenue synergies with the Square App and the Venmo platform (again, synergies between hardware and software).
So who might have the deep pockets — and the interest — to acquire Klarna? My guess is Meta.
Why Meta? Because it mastered the development and the ability to keep engaged network effects. People have created campaigns over the years to #deletefacebook, ‘gurus’ have written books about the dangers of social media and even streaming services exhibited movies to deep dive into the issues of these websites. And yet people can’t stop but to log in day in and day out.
Facebook (or Meta) is famous for showing retention and engagement metrics as slide 1 of each earnings presentation. The company understands that profit will follow consumer engagement and makes it crystal clear for anyone.
Additionally, Mark and the team have an aggressive acquisition history to block competitors to become more engrained in consumers’ life and they are not shy about paying a significant premium to accomplish that: from $19 billion in WhatsApp, to $2b to Oculus to $1b to Instagram.
Now, given that social commerce is among the most exciting new e-commerce trend, and that Meta wants to be the centerpiece everything Gen Z and Millennials-related, this acquisition seems a great fit.
For one, it would make today’s largest BNPL platform instantly connected with billions of new users. Second, it would allow businesses to offer new payments methods inside the Meta Universe (be it Facebook, Instagram or Oculus). It is easy to predict how effective a ‘shop now’ button on every Facebook Business Account, or at every Instagram story of your favorite influencer will be. Acquiring Klarna is like cracking two coconuts with one hit: it enable users to stay longer on the Meta platforms while bypassing the ecommerce websites, search aggregators and
Also relevant, buying Klarna would hinder TikTok’s (which is the most visited website in 2021) to forage into social commerce directly, although it has already established a partnership with Shopify to do just that.
As much as this can be a bold move, it would also rage politicians that have just recently blocked a $400 million deal (for context Klarna has *raised* more than 9 times that amount and was last valued at more than 100x).
2021 was the year we got acquainted to meme stock — and the power of social trading, we landed on Mars, Britney is free and Caeleb Dressel became the first swimmer to win gold medals in the 50 meter freestyle, the 100 meter freestyle, and the 100 meter butterfly at the same Olympics (his YouTube Channel is one of those corners on the Internet that everyone should check for his openess and candor on feedback and performance improvement. We should all have something similar). Now to a normal 2022!
For the help in reviewing, editing and suggesting better ideas (even if I don’t agree with them), I thank Anton Fox and Marilia Cavalcanti.
Disclosure: This is not investment advice and I have no knowledge if any of these are true in any shape or form, Block, Square or Metaverse related.