Given the state of the economy and capital markets, one might think internet dealmakers would lay low for a little while, but not everyone is predicting a dropoff in deals this year and next. JP Morgan analyst Imran Kahn, in a new report, says mergers and acquisitions among internet companies could grow significantly. Since most companies cannot look to the economy for growth (JP Morgan estimates GDP will decline 2.2 percent this), Kahn believes healthier internet companies will turn to acquisitions, and that they will target inexpensive smaller internet companies. Kahn analyzed the stock performance of large and small publicly traded internet companies, R&D budgets, cash balances and other criteria.
Highlights after the jump, including some of the internet companies Khan believes are ripe targets:
— Large internet companies have seen the value of their stocks hold up better than small internet companies: Last year, large internet stocks were down 48 percent versus 62 percent for smaller stocks. So far this year, large internet stocks have risen by 3 percent, while small internet stocks have continued to slide (23 percent). As a result, large internet stocks are trading at nine times earnings-before-interest-taxes-depreciation-and-amortization (EBITDA) — obviously an important measure when valuing a potential acquisition target — versus smaller internet stocks, which are trading at seven times EBITDA.
— Large internet companies may re-consider the “build vs. buy” strategy — they’ve been moving recently toward the “build” side of that continuum, which resulted in only 45 acquisitions in 2008 versus 94 in 2007, according to Kahn. While he predicts large internet companies will still increase their R&D spending by 8 percent in 2009, that is much less than the 25 percent increase in 2008. As they spend less on innovation internally, large internet companies will probably be on the hunt for smaller companies.
— Finally, the large internet companies have stockpiled a ton of cash as they grew significantly the past several years, and they will be looking for ways to make a solid return on that money. The top five internet companies — Amazon (NSDQ: AMZN), eBay (NSDQ: EBAY), Priceline, Google (NSDQ: GOOG) and Yahoo (NSDQ: YHOO) — have about $27 billion in cash sitting on their books. If you include Microsoft (NSDQ: MSFT) and Cisco (NSDQ: CSCO), that number increases to $77 billion. Even with the turbulence in the economy one can’t expect these companies to simply park their cash in a savings account. They will have to keep an eye out for attractive deal opportunities as a responsibility to their shareholders.
As for which public companies are most likely to be acquired? Kahn evaluated them according to brand strength, product leadership, ease of integrating the smaller company into the larger company, and barriers to entry to determine that Omniture, the online analytics company, and MercadoLibre, the Latin American e-commerce company, are the most likely to be acquired. Shutterfly, The Knot, and Expedia were also attractive candidates, according to the report.