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A new report from J.P. Morgan suggests that the future of Internet business starts with consolidation in 2009, as the biggest companies buy the best of the small.
With the economy approaching zero or even negative growth, Internet companies are still under pressure to grow — and the only way to do so is through acquisitions, J.P. Morgan Analyst and Managing Director
Imran Khan wrote in a report.
Large companies have every reason to put money into mergers, he added.
For one reason, the stock price of smaller companies (those with market capitalizations under $1 billion) is getting cheaper, while the stock of larger companies (those with market caps over $5 billion) is not. While large companies’ stock prices remains close in value now to their value at the start of the year, the stock of small companies has fallen in value by 23 percent, on average — potentially making them a steal.
At the same time, acquisitions would give large companies access to the fruits of smaller companies’ research and development, which is becoming increasingly critical as they trim their own research budgets. According to Khan, large companies have decreased the rate of growth of investment in R&D from 25 percent a year ago to a projected 9 percent this year.
Many large companies also still retain a significant cash hoard, Khan added. The five largest Internet companies — Amazon (NASDAQ: AMZN), eBay (NASDAQ: EBAY), Google (NASDAQ: GOOG), Priceline (NASDAQ: PCLN) and Yahoo (NASDAQ: YHOO) — together have a total of $26.8 billion in cash on hand.
Add related cash-hoarders Microsoft (NASDAQ: MSFT) and Cisco (NASDAQ: CSCO), and the total cash available for acquisitions balloons to $76.7 billion, Khan said.
Coupled with the fact that their stock prices have remained relatively stable, that mass of wealth gives large-cap companies plenty of options to do a deal whether they wish to use cash or stock.
So where will they start shopping?
Khan describes in very specific terms what acquirers are looking for.
“We believe the attributes that potential acquirers will seek include: 1) brand strength of the target, 2) product leadership, 3) ease of integration, and 4) barriers to entry,” he wrote.
He names two companies that are strong in all four of the above categories: Web analytics firm Omniture (NASDAQ: OMTR) and Latin American e-commerce platform Mercado Libre (NASDAQ: MELI).
Of course, the stock of Omniture and Mercado Libre is relatively expensive because the companies are able to charge the stock market a premium for an investment in their relatively strong and safe position.
Shares of OMTR were trading up 1.88 percent to $10.28 by late afternoon today, while shares of MELI were down 3.23 percent, to $14.10.
